 # FCFE and debt ratio

FCFE = NI - (1 - debt ratio) (Cap Ex - Dep) - (1 - debt ratio) (investment in working capital) What debt ratio do you use if you are given 2 different values? For instance, homie company will finance 40% of cap ex and working capital with debt financing…the company is currently financed with 30% debt and has a target debt ratio of 30%. For the formula, do you use 30 or 40%?

Since you are forecasting, use the target ratio.

Yes, use target structure if you’re given target in the problem. Otherwise, you use current cap structure

o27nov82 Wrote: ------------------------------------------------------- > Since you are forecasting, use the target ratio. But what if the problem gives you the next year forecast and you are forecasting for only that year? It is 2011 now. In 2012, The company will finance the increase in net fixed assets and working capital next year with 40% debt. The company currently has 30% debt with a 50% debt target ratio. 1. Calculate per share FCFE for 2012. We would use 40%, right? 2. Calculate the current value of a share. We would use 50% here, no?

If the company will finance the fixed assets with 40% debt, the firm’s cap structure will effective change. If it currently has 30% debt, after the fixed asset increase, cap structure will change to 35% debt/65% equity. Keep in mind they have a 50% debt target ratio, so the firm will borrow more to turn that 35% to 50%. 1) To calculate FCFE with target ratios, you would use a different formula: FCFE = NI - (1-DR)*(FC Inv-Dep) - [(1 - DR)*(WC Inv)], of course DR is the target d/a ratio 2) I’m not sure about this one, but I would use 50% personally

yes you use the TARGET ratio