The Daily Technical #128: Which line items are included in the calculation of net debt?

Good morning. Welcome to the 128th edition of The Daily Technical.

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OVERVIEW OF YESTERDAY’S QUESTION
What is the difference between unlevered FCF (FCFF) and levered FCF (FCFE)?

Unlevered FCF (FCFF): Represents cash flows a company generates from its core operations after accounting for all operating expenses and investments.

To calculate FCFF, you start with EBIT, which is an unlevered measure of profit because it excludes interest and any other payments to lenders.

You'll then tax effect EBIT, add back non-cash items, make working capital adjustments, and subtract capital expenditures to arrive at FCFF.

Tax-affected EBIT is often referred to as Net Operating Profit After Taxes (“NOPAT”) or Earnings Before Interest After Taxes (“EBIAT”).

FCFF = EBIT × (1 – Tax Rate) + D&A – Changes in NWC – Capex

Levered FCF (FCFE): Represents cash flows that remain after payments to lenders since interest expense and debt paydown are deducted.

These are the residual cash flows that belong to equity owners.

Instead of tax-affected EBIT, you start with net income, add back non-cash items, adjust for changes in working capital, subtract capex, and add cash inflows/(outflows) from new borrowings, net of debt paydowns.

FCFE = Cash from Operations – Capex – Debt Principal Payment

Common Mistakes

1. Starting with the wrong financial metric. Unlevered FCF calculations should begin with EBIT, while levered FCF starts with net income. Always confirm your starting figures align with the type of cash flow you are analyzing.

2. Overlooking tax implications can lead to inaccurate calculations (FCFF). You must apply the tax rate to EBIT to obtain NOPAT. Ensure you account for taxes properly to avoid skewing the results.

3. Omitting the impact of debt (FCFE). Levered cash flow considers changes in debt, so you must adjust for new borrowings and subtract debt repayments. Always review debt changes when calculating FCFE to reflect the accurate cash flow to equity owners.

4. Ignoring non-cash items like depreciation and amortization. These should be added back to EBIT for FCFF and net income for FCFE. Double-check to ensure all non-cash adjustments are included in your computations.
   

TL;DR

• Unlevered FCF (FCFF): Begins with EBIT; excludes interest; adjusts for taxes, non-cash items, working capital; subtracts capex. Represents operational cash flow before financial obligations.

• Levered FCF (FCFE): Starts with net income; includes interest and debt repayments; adjusts for non-cash items and working capital; subtracts capex. Represents cash available to equity holders post-debt obligations.

• Key Difference: FCFF measures operational cash flow excluding financials; FCFE measures cash flow available to equity after addressing liabilities.

• Formulas: 

  • FCFF = EBIT × (1 – Tax Rate) + D&A – NWC Changes – Capex

  • FCFE = Cash from Operations – Capex – Debt Principal Payment.

TODAY’S QUESTION
Which line items are included in the calculation of net debt?

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DEAL TALK
Scopely to Acquire Niantic’s Gaming Division for $3.5 Billion

Niantic Inc., the creator of Pokémon Go, is in talks to sell its gaming division to Saudi Arabia-owned Scopely Inc. for $3.5 billion​. The deal includes Pokémon Go, Monster Hunter Now, and Pikmin Bloom.

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