FCFE equity

andytrader

Why do we need to add debt borrowing minus debt repayment?

Is it assuming that new debt belongs to equity holders until it is being repaid?

kd26gioi

elcfa Wrote:
-------------------------------------------------------
> For FCFE: one takes the perspective of the equity
> holders ONLY. Think yourself now as the owner of
> sole proprietorship and you borrow from the bank,
> so cash available for you (as owner) is what you
> have generated from business and borrowed from the
> bank and/or paid the interest.

Thanks, this confirm my initial doubt.

"Is it assuming that new debt belongs to equity holders until it is being repaid?"

Beatnik

The reason net debt borrowing i.e. amount borrowed less amount repaid, is included in FCFE is because this cash flow belongs to the shareholders. What i mean by that is the net debt borrowed cash flow can be distributed to the shareholders in the form of dividends if the company wishes.

in other words, the equity holders have right to that cash.

kmf229

FCFE=CFO + Net borrowing - FCI

FCI is all Capital Expenditures. Now, FCI could be financed by Equity or it could be financed by Debt or by a combination of both.

Once, you subtract total FCI from CFO, you have reduced CFO by Capital Expenditures financed by Equity as well as by Debt.

You need to add back Debt Financing, so that you get
FCFE = CFO - Capital Expenditures financed by Equity only

To get it like this, you have to add back Net Borrowing.

Does it make sense?

JoeyDVivre

thanks elcfa....

spartanag07

I'm always a little weak on the accounting side of things, but here is my best shot.

A) My understanding is that net borrowing is not sustainable (ultimately to be paid back), so it doesn't represent the cash generating power of the firm. Thus it is not included in FCFF.

B) Changes in net debt, however, represent a shift in the division of cash flow between the equity holders and the debt holders. If you increase net borrowing, then equity holders get cash now (net borrowing results), and debt holders get cash later (interest payments). Ultimately these net out to the firm.

I am more confident of the FCFE statement than the FCFF statement.

sgupta0827

I think each you have explained some part of it, so I try to explain the whole thing, to give the whole perspective, just to make sure.

FCFF and FCFE is used to see what cash generated from the firm to either
the FIRM (ie., bondholders AND equity holders) or
the equity holders ONLY

One starts from CFO, cash generated from operations/business side (which already has the interest paid substracted) and substracts CAPEX (to sustain earnings).

For FCFF: one should reverse the effect for interest paid since you want to see what cash available before either the bondholders and equity holders get anything.
FCFF = CFO -capex + after tax interestpaid

No adding of net borrowing here since it does not make sense to count the money you (bondholders (and equity holders)) have given to yourself.

For FCFE: one takes the perspective of the equity holders ONLY. Think yourself now as the owner of sole proprietorship and you borrow from the bank, so cash available for you (as owner) is what you have generated from business and borrowed from the bank and/or paid the interest.

FCFE = FCFF - after tax interest + net borrowing.

RobertA

As a followup up to the original question, why is net debt not also added to FCFF?

FCFF=CFO + Interest(1-tr) - FCI
FCFE=CFO + Net borrowing - FCI

I understand interest paid would not be available to common shareholders, which is why it is not in FCFE. But, the net borrowing element should be available to the entire firm, if it is available to common shareholder -- right? I am probably missing something, thanks in advance.