There is a question:

How is Depreciation & Amortization treated while calculating DCF?

The correct answer given is that "we subtract it from EBITDA". However in the video, we are adding it. Could you please explain?

How is Depreciation & Amortization treated while calculating DCF?

The correct answer given is that "we subtract it from EBITDA". However in the video, we are adding it. Could you please explain?

Feb 07 2013 07:57 PM

The option "D&A should be subtracted from EBITDA" basically indicates what is done in the video were we start with EBIT (hence D&A is already subtracted from EBITDA) to show the unlevered net income.

Fundamentally this is how you calculate Unlevered FCF (UFCF)

1. Start with Earnings before interest and taxes (EBIT) x (1-Tax Rate)

2. Add back any dep/amortization (non cash expenses)

3. Subtract any changes in NWC (CA-CL)

4. Subtract any capex

5. Arrive at FCF

Now you will notice that the tax amount is applicable to EBIT and not EBITDA. Thats why first we start with EBIT (without the DA), then apply the tax rate to the EBIT, then add back D&A to reflect UFCF.

Unlike what you said in your answer, you cant just start with EBITDA (just because you are adding D&A back). If you start with EBITDA then the effective tax amount (lets say 30% of EBITDA) is different from the correct tax amount (30% of EBIT). So we start with EBIT, then apply the tax rate on this amount, then add back D&A.

Is this explanation helpful?

Feb 09 2013 10:39 AM
Fundamentally this is how you calculate Unlevered FCF (UFCF)

1. Start with Earnings before interest and taxes (EBIT) x (1-Tax Rate)

2. Add back any dep/amortization (non cash expenses)

3. Subtract any changes in NWC (CA-CL)

4. Subtract any capex

5. Arrive at FCF

Now you will notice that the tax amount is applicable to EBIT and not EBITDA. Thats why first we start with EBIT (without the DA), then apply the tax rate to the EBIT, then add back D&A to reflect UFCF.

Unlike what you said in your answer, you cant just start with EBITDA (just because you are adding D&A back). If you start with EBITDA then the effective tax amount (lets say 30% of EBITDA) is different from the correct tax amount (30% of EBIT). So we start with EBIT, then apply the tax rate on this amount, then add back D&A.

Is this explanation helpful?