luda002

I think we have consensus that an increase in NP is an increase in net borrowing. Can we also agree that an increase in preferred stock is an increase in net borrowing? We seem to have conflicting statements.

zhaoyp

Yes - issuance of preferred stocks increase net borrowing as they are treated like debt when calculating FCFE. They decrease net borrowing when dividends are paid on them or when they are no longer preferred, i.e. they are converted to common via a warrant or called via an option.

tarunajwani

Hello there everyone.

The concept of net borrowing is as follows

When you calculate FCFE you subtract the whole of FCINV and WCINV whereas we all very well know that a company is financed with both debt and equity. Since we have subtracted whole of the WCINV and FCINV by adding net borrowing we are simple adjusting the FCINV and WCINV for the investment made by equity holders

i.e (-WCINV-FCINV+net borrowings)= portion of the investment attribuable to equity holders.

secondly any current portion of long term debt/notespayable should not be included in net borrowings because this will be paid within the next year so it is not really a free cash flow available to the equity holders.

As regards the question that you have mentioned about the mock exam there are two mistakes in it

1) You do not include cash in calculation for working capital but they have included it.

2) Since they have included notespayable in wcinv already they are just subtracting it from the net borrowing which is again a wrong approach as notespayable should not have been included in wcinv in the first place.