Tax Shield and its Impact on Equity Holder Returns

  1. Financial Modelling
    1. Financial Modelling Introduction
    2. Financial Modelling Tools & steps
    3. How to Make a Financial Model and choose the best Company and Excel Workbook Setup?
    4. How to build a financial model Step-by-Step Guide to Excel Sheet Setup?
    5. Financial Statements: A Step-by-Step Guide to Extracting Historical Data
    6. Financial modelling excel
    7. Learn financial modelling Balance Sheets, P&L, and Assumptions Know About
    8. What is financial modelling Assumptions and Projections?
    9. Financial modelling and valuation
    10. Investment decision calculation
    11. The balance sheet’s asset side reveals the company’s line items.
    12. Revenue Model & Growth Rate in in P&L Assumptions
    13. Basics of financial modelling CAPEX and Asset Schedule
    14. Financial Analysis: Gross Block and CAPEX
    15. Gross block & Capex: Constructing the Asset Schedule
    16. Depreciation : Connecting P&L and Balance Sheet for Accurate Asset Forecasting
    17. depreciation expense : Exploring Different Methods in Financial Modeling
    18. Debt Management: Connecting P&L and Balance Sheet for Accurate Liability Projection
    19. Interest Rate Calculation & Debt Schedule
    20. Share Capital & Reserves
    21. IPOs and Under subscription : Bata’s Share Capital Dynamics
    22. Reserves & Surplus understanding Bata schedule
    23. Reserves and surplus schedule How to Build on Excel
    24. Financial modelling projections
    25. Balance Sheet Projections and Completing Reserves Schedule
    26. Cash Flow Statements Analysing Operations, Investments, and Financing Activities
    27. What Is Valuation for Investor
    28. Free Cash Flow Key Components, Formulas and How to Calculate?
    29. FCFF and FCFE uses in Mastering Free Cash Flow Calculation
    30. WACC Weighted Average Cost of Capital Analysis
    31. Market Risk Premium analysis
    32. Tax Shield and its Impact on Equity Holder Returns
    33. Weighted Average Cost of Capital and Terminal Growth in Valuation
    34. Terminal Value Understanding Perpetual Cash Flow Projections in DCF Model
    35. Learn Financial Modelling
    36. Free Cash Flow to the Firm (FCFF) Calculation with examples
    37. Stock Valuation DCF Model & Stock Market Value
Marketopedia / Financial Modelling / Tax Shield and its Impact on Equity Holder Returns

In the last chapter, we discovered that we could find the Free cash flow to the firm by adding back in non-cash expenses to Profit after taxes. These expenses included:



Deferred taxes

Proceeds from the sale of assets

Interest expense

Including the interest charge can be challenging, so we should take the time to comprehend how to put it in. To exemplify this, consider this example –

We can observe from the company’s bottom line P&L that their EBIT is 700 Cr with interest charges of 70Cr at 10%. Subsequently, their PBT equals 630 Cr and after a 25% tax rate, taxes amount to 157.5Cr. Ultimately, that brings us to their final PAT = 472.5 Cr which is arrived at by subtracting Taxes from PAT.

To calculate the Free cash flow to the firm, we begin with PAT and add back non-cash expenses. Also, we include the interest paid to demonstrate that it goes to the debt holder. Doing this should –

PAT = 472.5

(Add) Interest = 70

= 542.5

When we pay interest, the tax outflow decreases. For example, the tax rate here amounts to 157.5 Cr while the total interest paid is 70. If we consider the interest as 0, it would make PBT 700 and with a 25% tax rate, the outflow of taxation rises to 175.

The addition of interest should be taken into account for tax protection. To ensure this,

Interest (with tax shield) = Interest *(1 – tax)

= 70*(1-25%)


So when you add back interest to PAT to calculate the FCFF, we add 52.5 here and not 70. In this example –

PAT = 472.5

Interest = 52.5


To refresh your understanding, FCFF calculation requires…

FCFF = PAT + Depreciation + Amortization + Interest*(1-tax rate) + deferred taxes – working capital changes – investment in fixed assets (CAPEX).

We can start the FCFF calculation either with PAT or EBIT. If we choose to begin with EBIT, we must include the tax shield in our calculation.

FCFF = EBIT *(1-tax rate) + Depreciation + Amortization + deferred taxes – working capital changes – investment in fixed assets (CAPEX).

For our example, let’s use the equation provided above to determine the result.

= 700*(1-25%)

= 525

Omitting non-cash expenses, CAPEX, and working capital fluctuations makes keeping things simple. What matters most is that the FCFF figure will be consistent whether you begin with PAT or EBIT.

You can ascertain the free cash flow to the equity holders by subtracting the net debt from the free cash flow to the firm.

Free Cash flow to Equity = FCFF + [Debt – Principal repayment]

Where, [Debt – Principal repayment] = Net debt


Free Cash flow to Equity = FCFF + Net debt