The formula
FCFF = EBIT × (1 - t) + D&A - ΔNWC - CapEx.
Why strip out interest?
FCFF asks: how much cash does the operating business produce before deciding how to fund it? Interest expense is a financing cost. By using EBIT (not net income) and applying a proxy tax, we get a number that does not flatter highly levered firms or punish unlevered ones.
Which tax rate?
Convention is the effective tax rate from the income statement, not the statutory 21% US rate[IRS Pub 542]. Marginal rate is defensible for forward-looking models; statutory rate is too clean to be true once foreign income and credits are layered in. For a US domestic-only filer the effective rate often clusters near 23-25%.
Worked walk (illustrative numbers)
A negative number in ΔNWC means working capital released cash, so the subtraction of a negative adds back. Sign conventions follow ASC 230[ASC 230].
When to prefer FCFF over Standard FCF
- You are building a DCF and the output discount rate is WACC.
- You want to compare two firms with different debt loads.
- You want a metric that does not shift when management refinances.