Calculating FCFE

CFA Level II Equities
#1

Hi,

I was doing the Alathab case on the 2011 afternoon mock. It asked to calculate FCFE for 2010 on one of the questions.

Some values for 2010:

NI: 120 EBITDA: 275 Depreciation: 82.5 Interest expense: 16 Tax: 35%

I was using the FCFE = NI + NCC - FCI - WCI + NB formula, the answer decided to use the EBITDA formula which is: FCFE = EBITDA(1 – Tax rate) – Int(1 – Tax rate) + Dep(Tax rate) – FCInv – WCInv + Net So my questions as follows: 1) Shouldn’t NI + NCC = EBITDA(1-T) - Int (1 - T) + Dep(T)? The rest of the values in both formulas are constant (FCI, WCI and NB) so I’m assuming these two portions should give you the same answer in either formula. However in this case: NI + NCC = 120 + 82.5 = 202.5 EBITDA(1-t) - Int(1-t) + D(t) = 178.75 - 10.38 + 28.87 = 197.24 from their answer Why are these different? 2) When calculating Net Borrowing, there were the following values given for 2010/2009: Notes payable: 20, 15 Long term debt: 157.5, 150 My question is why did they subtract the change in notes payable? The change in long term debt is 7.5 and the change in notes payable is 5. Isn’t an increase in notes payable considered borrowing? I did 7.5+5, but they did 7.5-5 Thanks

#2

(275 - 82.5 - 16) * .65 = 114.72 (NI which doens’t equal the 120 provided)

NI + NCC - (INT * 1 - T)

(275 - 82.5 - 16) * .65 = 114.72 + 82.5 = 197.22

Seems like there’s a peice of missing information from the problem that forces you to use EBIDTA method in place of the NI method for FCFE calc. Not sure what’s going on in the second question but I would re-read the problem and see if there is a minor detail somewhere.

#3

I’m not sure if there’s any missing information…I think the question might just be wrong?

That takes me back to my second question. Looking at an example (page 314 in CFAl Book 4), the example has an increase in notes payable and an increase in long term debt which they add up to get net borrowing…

#4

i definitely have in my notes that Net borrowing = Net change in LT debt + ST debt

Looks like this is a known problem, comfirm your referencing problem 51 as well?

http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91313176

#5

Yup, problem 51. Good to know I’m not going crazy.

I wonder if my first question is a mistake on their end as well…

#6

Just wanna share what i have been told is a classic CFA trap…!

In this problem, we cannot start with NI (that would implicity assume a different tax rate of ~32%) vs. in the problem it asks you to specifically go with a 35% tax.

As for N/P -> the curriculum includes it in the Net borrowing.

#7

Oh…so we should check the implied tax rate vs the tax rate we are told to use before choosing what formula we use? So tricky…

Anyway so if I recalculate NI for the 35% tax rate the answer should be the same for both formulas then…

#8

You can try doing what you proposed

i had this other mock question where EBITDA (was adjusted for some other non-recurring items), so if you would start from NI (and even if the tax rates) are the same, you would get the wrong answer…so…dont know what’s the best approach…

Another classic is the PVGO problems (in Equity)- no one know what is the right apporach for Equity questions on PVGO…guess it almost feels like walking on a landmine, never know where is the trap…EOC problems & BB examples for this one seems to contradic whats in the mocks :frowning:

#9

Lol well maybe I should stick to the EBIT/EBITDA formulas by default then just to be safe…damn.

#10

Seriously? That doesn’t seem like a fair testing strategy.