How do I calculate FCFF starting from EBITDA?
CFA Level II has multiple approaches to computing free cash flow to the firm. I keep mixing up the adjustments when starting from EBITDA vs. net income vs. CFO. Can someone show the step-by-step bridge from EBITDA to FCFF with a worked example?
FCFF (Free Cash Flow to the Firm) represents cash available to all capital providers — both debt and equity holders — after reinvestment. Starting from EBITDA is one of the cleanest approaches.
FCFF from EBITDA Formula:
> FCFF = EBITDA x (1 - t) + Dep x t - CapEx - Change in Working Capital
Or equivalently:
> FCFF = EBITDA - Taxes on EBIT - CapEx - Change in WC
> FCFF = EBITDA - [EBITDA - Dep] x t - CapEx - Delta WC
Why this works:
- EBITDA is before depreciation, interest, and taxes
- We need to subtract taxes, but only on operating income (EBIT), not on EBITDA. Since EBIT = EBITDA - Dep, taxes = (EBITDA - Dep) x t
- The depreciation tax shield (Dep x t) effectively gets added back
- CapEx and working capital investment represent cash reinvested in the business
Worked Example — Crestline Industrial:
| Item | Amount ($M) |
|---|---|
| EBITDA | $240 |
| Depreciation & Amortization | $50 |
| Tax rate (t) | 25% |
| Capital expenditures | $70 |
| Change in working capital | +$15 (increase = cash outflow) |
Step 1: Calculate taxes on EBIT
- EBIT = $240 - $50 = $190
- Taxes on EBIT = $190 x 0.25 = $47.5
Step 2: Compute FCFF
- FCFF = $240 - $47.5 - $70 - $15 = $107.5 million
Verification from Net Income:
Let's cross-check using the NI approach. Assume interest expense = $20M.
- EBT = $190 - $20 = $170
- Tax = $170 x 0.25 = $42.5
- Net Income = $127.5
FCFF from NI:
- FCFF = NI + Dep + Int x (1 - t) - CapEx - Delta WC
- FCFF = $127.5 + $50 + $20 x (0.75) - $70 - $15
- FCFF = $127.5 + $50 + $15 - $70 - $15 = $107.5 (matches)
All Starting Points for FCFF:
| Starting Point | Formula |
|---|---|
| EBITDA | EBITDA(1-t) + Dep(t) - CapEx - Delta WC |
| EBIT | EBIT(1-t) + Dep - CapEx - Delta WC |
| Net Income | NI + Dep + Int(1-t) - CapEx - Delta WC |
| CFO | CFO + Int(1-t) - CapEx |
Exam tips:
- Interest is added back because FCFF is before financing costs. Always add Int x (1-t), not the full interest.
- Working capital increases consume cash (positive delta WC is subtracted)
- If depreciation is given separately from amortization of intangibles, both should be added back
- Watch for non-cash charges like impairments — these should be added back to FCFF
Practice FCFF calculations with our CFA Level II equity question bank.
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