no need to read further

CFA Level II
#1

I got the answer, no need to read further

Formulae given in the curriculum

  1. FCFE = NI - (FCInv - Dep) - WCInv + DR(FCInv - Dep) + DR(WCInv)

  2. FCFE = NI - (1-DR)(FCInv - Dep) - (1-DR)(WCInv)

I did EOC # 6 in Free cash flow valuation reading and when i was applying net borrowing = DR(FCInv - Dep) + DR(WCInv) and getting direct FCFE number. Also if the question states that 20% of net investment in assets will be financed with debt, shouldn’t we get the FCFE number using first formula, but it isn’t the case instead the solution applies second formula for equity financing.

I am confused regarding these two formulae, where do we apply them given the information in the question and how does net borrowing equation is giving me direct FCFE number.

#2

#nevermind

There are two differences between net income and free cash flow. The first is the accounting for the purchase of capital goods. Net income deducts depreciation, while the free cash flow measure uses last period’s net capital purchases.

Measurement Type Component Advantage Disadvantage Free Cash Flow Prior period net investment spending Spending is in current dollars Capital investments are at the discretion of management, so spending may be sporadic. Net Income Depreciation charge Charges are smoothed, related to cumulative prior purchases Allowing for typical 2% inflation per year, equipment purchased 10 years ago for $100 would now cost about $122. With 10 year straight line depreciation the old machine would have an annual depreciation of $10, but the new, identical machine would have depreciation of $12.2, or 22% more.

The second difference is that the free cash flow measurement adjusts changes in net working capital, where the net income approach does not. Typically, in a growing company with a 30-day collection period for receivables, a 30-day payment period for purchases, and a weekly payroll, it will require more working capital to finance the labor and profit components embedded in the growing receivables balance.

When a company has negative sales growth, it’s likely to lower its capital spending. Receivables, provided they are being timely collected, will also ratchet down. All this “deceleration” will show up as additions to free cash flow. However, over the long term, decelerating sales trends will eventually catch up.

Net free cash Flow definition should also allow for cash available to pay off the company’s short term debt. It should also take into account any dividends that the company means to pay.

Net Free Cash Flow = Operation Cash flow – Capital Expenses to keep current level of operation – dividends – Current Portion of long term debt – Depreciation