Hi all - in forecasting FCFE, the formula given is: NI - [(1-DR) x (FCInv-Dep)] - [(1-DR) x WCInv)] I understand we use the above formula because we are not given Net Borrowings, but I don’t understand how we can go from Net Income to FCFE without adding in any sort of borrowings…all we are doing is reducing Net Income by the portion of capital expenditures paid for using Equity. Thanks!
Think of it this way:
This portion here [(1-DR) x (FCInv - Dep)] is taking into consideration only your portion of equity used. Hence the 1-DR (debt/assets).
We never explicitly include any financing costs, so there is no need to add back in net borrowings.
We’re esentially eliminating the need, at least that’s how I understand it to be
By keeping your capital structure the same as the assumption of 1-DR makes, then you need to borrow money in the form of debt as you increase your balance sheet size. So instead of subtracting net fixed and working capital investments, then adding some borrowings that used to finance them, you subtract only the part of these investments that are financed with equity, with the remianing being available to shareholders.
FCFE is basically what is left after paying to all debt holders and all. So in short FCFE is only for Equity holders.
In second formula, Company is maintaining Target Debt/Assets in coming years and if you look at the formula, Borrowing aspects has been included in each FCinv and W Cap and same has been reduced by the taking 1- D/A so that only equity portion is remain.
So in short this formula remove the effect of debt holders from NI
Hope it helps
Thanks…I think it is starting to make sense to me…however, would be much appreciated if you can please walk me through the following example: FCFE = NI + NCC - FCInv - WCInv + Net Borrowing Forecasted FCFE = NI - [(1-DR) x (FCInv-Dep)] - [(1-DR) x WCInv)] NI = 5 Depreciation (NCC) = 1 FC = 2 WC = 2 Net Borrowings = 4 Debt/Assets = 50% Using formula 1: FCFE = NI + NCC - FCInv - WCInv + Net Borrowing FCFE = 5 + 1 - 2 - 2 + 4 FCFE = 6 Using formula 2: Forecasted FCFE = NI - [(1-DR) x (FCInv-Dep)] - [(1-DR) x WCInv)] Forecasted FCFE = 5 - (.5 x [2-1]) - (.5 x 2) Forecasted FCFE = 3.5 Should these not yield the same result? Thanks!
anyone ? 
You are borrowing $4 to finance $3, that isn’t a 50/50 debt ratio. To keep the capital structure constant, net borrowings must only increase by $1.5, which is half of your net investments.