In forecasting FCFE by individual components of it. We also forecast the “gross fixed capital investment” and “depreciation” . So, while calculating the net borrowing , why do we take it as the debt ratio multilplied by the net fixed investment (gross fixed cap investment - depreciation), and why not only multiply it by the gross fixed capital investment as that is the amount which is the actual cash borrowed for that fixed capinv and on this cash we are borrowing.
If you realize, eventually it is the Net Fixed investment that is being financed with debt ratio for the calculation of FCFE because depreciation is a non cash expense and added back to NI.
FCFE = NI + Dep - Capex - WC + Net Debt
Rearranging the Depreciation: FCFE = NI - (Capex - Dep) - WC + Net Debt
I can understand this from the formula. But why should logically , the net fixed inv. Be financed by debt and why not by the gross fixed investment. My argument is that , in cash flow , I am saying purchase of fixed assets of say 100 crs. Which is the actual cash outflow for investment. So am I not borrowing debt ratio * 100 crs ?
Yeah, me wondering the same issue. I am learning the Reading 31 and confused with the formula in the 6th question at EOC as well.
The net borrowing need to cover the incremental fixed investments, that’s why you need to deduct depreciation from your calculation.
Hope it helps.