FCF and FCFE, my contribution to the confusing question 150, question, another, increase

soverby

Hi,

We all agree with this formula : FCFE = FCFF – (1-T) Interest Expense + Net borrowing.

Net borrowing = Increase in LT Borrowings - Debt repayment.

In the balance sheet, the increase in note payable from one year to another (except if more information are given) correspond to the current portion of LT debt which is a debt repayment.

So, back to our problem

1) LT debt increased from 150 to 157.5 = +7.5

2) Notes Payables increased from 15 to 20 = +5 (which is a repayment).

Because the company borrows more in the year than it repays it will have additional funds - net borrowing - that is added to FCFF in order to determine FCFE.

Then the net borrowing is 7.5 - 5 = 2.5 ! CQFD

In conclusion, I think, it's not an error. Your contribution would be appreciate if you don't agree with this.

BK

yodacaia

Point #2 is not a repayment its additional debt, payables increased from 15 to 20. The calculation should be 7.5+5 = 12.5

iteracom

With all due respect, erobak's assertion that an increase in Notes Payable to be a debt repayment is incorrect.

Please refer to the Solution to #3 on page 407 [Volume 4 - Reading 43 - Free Cash Flow Valuation] in Example 6 clearly shows that an increase in Notes Payable increases Net Borrowing. The question asks you to find FCFE from Net Income. Net Borrowing was determined as $75M due to an increase in Notes Payables of $50M and an increase in L/T Debt of $25M.



Edited 1 time(s). Last edit at Sunday, May 22, 2011 at 11:02AM by wbrocks.