There was a question where they give you EPS and tell you the capex and WC per share as well. Then they say it’s 40% financed by debt and 60% by equity.
The solution was EPS less 0.6 * capex less 0.6 * WC = FCFE, then you divide by r-g to get equity value.
Is there a reason why we are ignoring net borrowing here? It is positive in this case (ie they borrowed money).
Thanks so much.
I guesss they have already included the borrowing component by multiplying the cap and wc by 0.6.
That is including net borrowing. Another way to arrive at FCFE in your case is (and assuming there is no NCC):
FCFE = EPS - WC - FCInv + .4(WC +FCInv).
Which is basically what you’re doing except quicker, but maybe less intuitive. My way is more intuitive because it spells out the net borrowing: .4(WC+FCInv).
Here’s how I teach it: If you have $100 of Capex and you finance 60/40 debt and equity, You’ll have a $100 outflow from Capex and a $60 inflow from borrowing. Likewise for WCINV. So, since you’re calculating FCFE, all you care about is the net effect. In this case, you only have to account for the 40% outflow after debt financing.
NOTE: this works only for calculating FCFE, and only when you assume a constant D/E ratio in financing.