Hi all! Need some help understanding a FCF Valuation problem found in the Schweser study notes (Book 3, Page 137, Concept Checker #1): 1. The Gray Furniture Co. earned 3.50 per share last year. Investment in fixed capital was 2.00 per share, depreciation was 1.60, and the investment in working capital was 0.50 per share. Gray is currently operating at its target debt-to-assets ratio of 40%. Thus, 40% of annual investments in working capital and fixed capital will be financed with new borrowings. Shareholders require a return of 14% of their investment, and expected growth rate is 4%. The value of Gray’s stock is closest to: A. 27.04 B. 29.90 C. 30.78 What confuses me is how they arrive at FCFE: FCFE = NI - (1-DR)(FCInv-Dep) - (1-DR)(WCInv) FCFE = 3.50 - [(1-.04)(2.00-1.60)] - [(1-.40)(0.50)] = 2.96 My train of thought brought me here: FCFE = NI + Dep - WCInv - FCInv + Net Borrowings FCFE = 3.50 + 1.60 - 0.50 - 2.00 + [(0.40)(2.00+0.50)] Where did I go wrong??
Well . . . if you do the algebra you find that the difference between the formulae is that the first has a term of
-DR × Dep
that isn’t in (your version of ) the second. The only place it could fit in the second formula would be embedded in Net Borrowing, but I’m not sure why you would decrease Net Borrowing by the financed portion of the depreciation expense.
In short, the formulae seem inconsistent. I’m not sure if the CFA Institute book explains that or not; I didn’t see anything in the SchweserNotes that did.
Sorry.
S2000 did you study for all 3 levels mostly with SchweserNotes only?
S2000 did you study for all 3 levels mostly with SchweserNotes only?
Yes.
I also took a 2-day or 3-day review for each level. My Level I review was taught by Carl Schweser himself. My Level II and Level III reviews were taught by the gentleman who succeeded Carl: Andy Temte.
That’s why I’m so confused. I don’t understand what Scwheser is doing. From my knowledge, FCFE = NI + NCC - WCInv - FCInv - Int(1-t) + Net Borrowings but I have no idea what is going on with their answer of FCFE = NI - (1-DR)(FCInv-Dep) - (1-DR)(WCInv)
int is added
Is that latter formula in the CFA Institute book?
One more way to calculate this :
FCFE formula says NI + NCC - FCinv - WC Inv + Net Borrowigs.
if in the given question we consider only equity portion ( since debt to assets 0.4 is given ) as we need to arrive at FCFE then
NI - 3.5
- NCC - 1.6 * 0.6
-
FC inv - 2 * 0.6
-
WC inv - 0.5 * 0.6
- Net borrowings - 0 **( coz we are considering only equity portion here in the above analytics )
FCFE = 2.96
Hope this helps…
What do we do for amortization expenses in case of FCFE if debt ratio is given ?
Data for year 2012 (last year)
Net income $27.5 million
Depreciation charges $5 million Change in working capital investment $0.8 million Change in fixed capital investmen t$4.2 million Amortization charges $4 million Target debt ratio 40.0%
What is the free cash flow to equity for Yogo Inc. in 2012? a) $29.9 million b) $27.5 million c) $24.14 million
If answer is A) 29.9
27.5 + 5*0.6+4*0.6-0.8*0.6-4.2*0.6= 29.9 m
Amortization exp is added back to net income treated same as depreciation as it is also non cash charges debited previously to profit & loss .hope this helps…
Thanks
ALSO can u explqain me concept of use of FCFF .How can we calculate interest expense form FCFF ?
One more way to calculate this :
FCFE formula says NI + NCC - FCinv - WC Inv + Net Borrowigs.
if in the given question we consider only equity portion ( since debt to assets 0.4 is given ) as we need to arrive at FCFE then
NI - 3.5
- NCC - 1.6 * 0.6
-
FC inv - 2 * 0.6
-
WC inv - 0.5 * 0.6
- Net borrowings - 0 **( coz we are considering only equity portion here in the above analytics )
FCFE = 2.96
Hope this helps…
FCFF is basically cash flow pre interest and pre borrowings that is why we add back interest post tax to net incomei.e PAT( post tax ).
FCFF = NI + NCC + Int(1-T)i.e interst post tax - Fc Inv - Wc Inv.
to arrive at interest expense.
interest (1-T) = FCFF (assuming given ) - NI - NCC + FC inv +WC Inv.
is this formula needed for exam ?
Uses of FCFF = Increase in cash + Interest*(1-t) – Net borrowing + Cash dividends – Net issuance of shares
I would definitely tke a review course for L3. But how would you recommend regarding to final stage review, given there are only 21 days left, and I have finished reading once but do not remember much. Thanks S2000 
I would definitely tke a review course for L3. But how would you recommend regarding to final stage review, given there are only 21 days left, and I have finished reading once but do not remember much. Thanks S2000
Ahhh I see. But what I still don’t understand is why is the 0.6 (the equity portion) applied to NCC? Is it simply along the same thought that 40% of the depreciation belongs to debtholders and 60% belongs to equity holders?
Thank you for your time. This really helps!
Questions, questions, questions, questions, questions.
Do as many questions as you can. If you miss an idea more than once, review it in the book; otherwise: questions.
If you can do one or two practice/mock exams, do those, under conditions as close to real exam conditions as you can get (three hours in the morning, lunch break, three hours in the afternoon: no distractions).
Best of luck!
My pleasure.
After some digging, I finally understand that it is common to assume that the firm mantains a target debt-to-assets ratio for net new investment in fixed capital and working capital. Thus, net borrowing may be expressed without having to specifically state debt issuance or repayments: FCFE = NI - [(1-DR)(FCInv - Dep)] - [(1-DR)(WCInv)] FCFE = 3.50 - 0.24 - 0.30 = 2.96. Now I see that net borrowing is embedded into the formula through 1-DR. Now my last question is, why is Depreciation subtracted from Fixed Capital Investments?