Question 5 asks to calculate the value of equity starting from FCFF, providing you with FCFF, Interest Expense, Tax Rate, Net Borrowing, Long-Term Real Growth Rate, and Real Return on Equity.
My understanding was to adjust FCFF by reducing it by:
Interest * (1-tax)
To get FCFE. Then from FCFE:
FCFE * (1 + g) / (r - g)
At this point we add the net borrowing to result at total equity value.
However the question adds net borrowing to FCFE before doing the equity value formula above. This implies they are borrowing $52 million each year, growing, in perpetuity.
Is this accurate? The only reason I can come up with is to do with constant capital structure or something. But in the question they don’t imply anything about constant borrowing each year.
FCFE = FCFF - Interest (1-t) + net borrowings
well this is the basic formula considering its the day before the D-Day dont go into such detail just memorize this formula and we can get back to this interesting debate later
The problem is this is far too oversimplified for a CFA exam. These mocks are so easy I’m worried they aren’t representative of what the real thing is going to be.
there is also a form in which they dont provide you net borrowing and rather a debt ratio or equity ratio is provided
FCFE= NI + Dep Expense - DR * investment in FC - DR * investment in WC
Trust me there are so many form of this FCFE model that is it not difficult for them to get us confused about what to use.
Simplify the complicated side; don’t complify the simplicated side.
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