# Equity & FSA Qs!

Please help me with the following: 1/ The formula for FCFF and FCFE when there’s preferred stock 2/ How to revise WACC to incorporate cost of preferred stock? 3/ Summary of entries on how to capitalize operating leases. Thanks a lot!

Treat preferred stock like debt, except preferred stock are not tax-deductible. Preferred dividends are added back to FCFF. This is assuming that Net Income calculated is to equity shareholders after dividends have been subtracted out. FCFF = NI + NCC + Int(1-tax rate) + preferred dividends - FCInv - WCInv The only adjustment to FCFE would be modify net borrowing to reflect new issuance by the amount of preferred stock. FCFE = FCFF - Int(1-tax rate) - preferred dividends + Net borrowing + Net issuance of preferred stock WACC = rd x (1-t) x wd + re x we + rpd x wpd http://www.analystforum.com/phorums/read.php?12,1132255

1. FCFF = FCFF from other methods + preferred dividend FCFE - no change 2. rd*(1-t)*wd + rp*wp + re * we = wacc weights would be based on market value / book value used consistently for all items. 3. You would be provided operating leases for certain # of periods + pv of operating leases to the future. Find out PV of that cash flow stream using the “lease discount rate” provided. add that PV to Assets. Now to distinguish between portion going to the Current Portion of operating Leases vs. the LT portion of Operating Leases: Maybe best to explain with an example: Lease payment = 2000 Interest rate = 10% LT Lease (PV of lease payments) = 12288 Current Portion of Lease = 2000 (Lease Payment) - Interest Expense (12288*0.1) = 771.2 Long term portion=12288-(2000-1228.8)=11516.8 Equity remains same because A and L have same addition # in both locations. Based on teh above D/E will now Increase, TA/E will also increase (indicating leverage has gone up).

cpk, you say FCFE is unchanged with preferred dividends? Isn’t idreesz correct with his FCFE formula?

Idreesz is correct, so am I. I am starting with Net Income, Idreesz with FCFF. He added Pref div. to arrive at FCFF. So needs to remove it to get to FCFE from FCFF. I am using NI -> so NI + Depr -WCInv - FCInv + Net Borrowing = FCFE NI+Depr+Int(1-t) + Pref Div-WCInv - FCInv=FCFF

FCFE no change if you start with Net Income or Op Income. FCFE changes if you start with FCFF as idreesz correctly indicates

Well, what threw me off was that you said no change to FCFE. You have to include the “net issuance of preferred stock” along with the usual Net Borrowing… I guess reading 2 posts that basically say the same thing is messing with my head…

Thanks so much everyone, I have a feeling these would show up. We’ll see Capitalisation of OL to an FL is done in the following manner you’ll be given yearly payments, life of asset & an interest rate calculate the PV of those yearly payments For analysis The PV is added to both assets & liabs Interest payment = PV * Interest Rate Depreciation = PV/Life of asset Since it’s an asset, you’ve to depreciate it and libility is treated as debt EBIT- Depreciation + Annual lease payment (, it’s analytical; so we add back the lease payment) Interest expense = previous interest expense + Current calculated expense