# 2012 CFAI Mock Question #50 FCFF

Find FCFF for National:

I know the equation to be: NI+Dep+(int*(1-t)) - WCInv - FCInv

Ni = 156 Dep = 61 Int (adj) = 32 WCInv = -6 (so we add it) …and here is my problem I have FCInv to equal the change in the long term assets (1203 -1130 = 73) CFAI calculates it as change in long term assets + 61… I assume that the “61” is depreaciation but I don’t think I have run across Dep. being added back to FCInv in any other question regarding FCFF (I could very well be wrong)

Anybody knows what the “61” is? Why is it added to FCInv? Do we always add it to FCInv?

Depends on if you are given change in NET LT assets or change in GROSS LT assets. Since 1203-1130 are net numbers you need to add depreciation to get ur FCInv

i think it’s because you are given “net” LT assets, therefore you have to adjust for depreciation that year. more commonly, you are given gross PP&E - then you just take ending minus beginning gross PPE to get your FCInv.

I think there is a mistake in solution. If we want to find Capex from Change of Net asset, we need both Dep exp of 2 consecutive year. I think it should be (1203 + 61)-(1130+X) … X is missing input Why would you need depreciation from the year before? Ending should = Beginning - Depr + FCINV

If you assume no PPE were sold during the year (ie, anything you would need to depreciate), the change in PPE is depreciation. Think about it… if you don’t buy any new assets or sell any during the year, Ending NET ppe on the balance sheet will just change by depreciation. Depr flows through the income statement, and reduces equity. FC INV will be 0. Net ending = Net beginning - Depr

However, if they buy assets during the year this will be reflected in the change in net AND depreciation… they need to start depreciating whatever they purchased, which will be included in depr. So, net assets will increase by the amount of the purchase, but will be reduced by incremental depreciation (which is usually just included in the depreciation amount).

With PPE purchases, ending net ppe = beginning net PPE - depreciation of old assets + purchases(FCINV) - depreciation of assets purchased during the year. But, the two depreciations are usually combined together into total depreciation expense for the year. so, ending net = beginning Net + purchases - depreciation

OR, FCINV = Net Ending - Net Beginning + depreciation. If the firm purchases more assets than the amount of depreciation, the difference in Ending PPE - Beginning will be positive. (In forecasting FCFE, this is an idea the forecasting of FCINV is based off of, that as a firm grows, it will consistently invest an amount in PPE over and above depreciation expense, hence the use of FCINV - Depreciation)

When assets are sold, there is another wrinkle added. Sometimes they give you value of what was sold, sometimes you need to calculate it.

ending NET = beg NET + purchases - BV sold - depreciation. It is the book value of sold in this equation, because the sold asset, if you have NET PPE, will be included in the Beginning PPE at its net, or book, value

FCINV = Capex (or purchases) - Proceeds from sale. Notice you subtract the proceeds, not the gain or BV. If given these separately, they need to be calc’d. For instance, you might seen a gain on sale on the I/S, and be able to calculate purchases. You need to be given at least or at least be able to figure out one of these, though.

If they sell something but dont make any purchases, then FCINV will be added to cash flows by the proceeds from the sale (this cant continue indefinitely, keep in mind)

yeah, you’re right. interesting Once you think you understand an FRA topic they throw in these twists and turns. I am beginning to think that I will never understand FRA, there are too many exceptions to the rules. I think I may just wait to retake L2 in 2020 when there will be just one accounting procedure!!

Well, the accounting for PPE is more or less a level 1 topic. The effort to learn it now is worth much more than spending 4+ months studying everything again next year

@kwalew: Can u tell me why the question number 48, morning mock exam 2012 CFAI they calculate adjusted ROE of 2011 = adjusted NI of 2011 / adjusted Equity of 2011 ???

I think it should be NI/ begining E of 2011 or equivalent ending E of 2010 = (160-30)/1305

either way it should be Adjusted NI divided by Average Equity (original amount of 2010 and adjusted number for 2011)

Unfortunately I’m not familiar with the question and havent taken the mock yet - Usually ROE should be based on beginning equity (the net income from the year is in ending equity, so the change would be violations of clean surplus and dividends)

If this is a residual income model problem, they may have made adjustments to assume a clean surplus relationship…