Question

can someone please explain why when calculating the FCFF we add only the after tax interest cost and not the full interest cost?

Answer 1

Do you mean why we add the after tax interest cost to the Net income?

It is because the net income already accounts for the tax deductible; so now you just need to add Int(1-T). The Int(T) is already included in the net income. Do you get my point?

Answer 2

I see, but how int(T) included in Net income?

Answer 3

Net income includes the interest paid to the company’s bondholders, but the definition of FCFF is the cash available to the firm’s bondholders and equity holders. So it is the money before paying the interest, thus, we need to add back the after tax expense of interest

Answer 4

Int(t) is the tax deductible. When you calculate net income you remove the interest then you multiply by the tax rate; this takes into account the tax shield. You have just reduced the taxes.

Answer 5

I forgot to add something, when you have interest in a company then your taxes will be reduced by Int(T). So when you want to get EBIT(1-T) from Net Income all you need to add is Int(1-t) since Int(T) is already there (lower taxes).

Don't forget Int(1-T)+Int(T)=Int