FCFE formula

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charu_mulye

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There is one formula on CFAI volume 4, page 380 [ reading 42].
FCFE = NI - (1-DR) (FCinv - DEP)- (1-DR)(WCinv)
Here is how they derive it:
1) FCFE = NI + NCC - FCinv - WCinv +net borrowing [This is fine standard formula ]
Then there is one assumption that only significant NCC is Depreciation.
2) Net Borrowing = DR(FCinv - DEP) + DR (WCinv)
DR = debt to assets ratio. When we susbstitute Net borrowing from 2 to 1 and NCC = DEP we get the formula.
What I don’t understand is how the equation for Net borrowing is derived ??
Please help.
Thanks
 
Assume that the company is mature, and that the FCInv less depreciation and the WCInv are being financed through Debt - by borrowing at the debt ratio.
So in this case
DR * (FCInv-Depr) = Amount of Net Borrowing for the FCInv
DR * (WCInv) = Amount of Net Borrowing for WCInv.
Hence the formula…
NI - (1-DR)(FCInv-Depr) - (1-DR)WCInv
 
It basically gives you the split of the net borrowing for Fixed Capital Investment and Working Capital Investments as cpk mentioned earlier.
 
Beware: Master Free Cash Flow valuation concept to the detail. CFA completely skipped it in the whole of the Level 2 exam in 2008. It will def be on the 2009 exam.
 
AllLevelsPass Wrote:
——————————————————-
> Beware: Master Free Cash Flow valuation concept to
> the detail. CFA completely skipped it in the whole
> of the Level 2 exam in 2008. It will def be on the
> 2009 exam.
Thanks for the Tip..anyway i would expect either of Free cash flow / residual income 100% on exam.
i have already made it sure that i have got this concept thoroughly..
For exam like this – one should not predit what will show up…rather study everything..
There might be some weak spots but for concepts at least nothing should be skipped..
 
If we expand FCFE = NI - (1-DR) (FCinv - DEP)- (1-DR)(WCinv)
we get NI + (1-DR) Dep and other terms…
Question i have is why do we add back only part of Dep(ie (1-DR) Dep ) and not entire Dep to NI as it is done in other formulae?
I am sure i am missing why it is done so if it is done or else other part of Dep is added in other terms???
Please clarify
thanks
 
This formula for FCFE is based on the fact that
a. FCINV = (Total Expense of FCInv - Depreciation)
you are financing a part of that with Debt - so how much Debt are you using???? based on your target debt ratio.
If you started from NI to arrive at FCFE
FCFE = NI + Depr - FCInv - WCInv + Net Borrowing.
Net Borrowing = DR ( FCInv - Depr) + DR (WCInv)
(FCInv - Depr) is the amount of FC Investment made in excess of Depreciation incurred.
Now substitute back in the FCFE formula – and then you get the simplified version
FCFE = NI - (1-DR)(FCInv-Depr) - (1-DR)WCInv.
 
swaption – you are confusing over TR and DR in the above….
 
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