Harrisburg Tire Company (HTC) forecasts the following for 2007. Earnings (net income) = $600M Dividends = $120M Interest expense = $400M Tax rate = 40% Depreciation = $500M Capital spending = $800M Total assets = $10B (book value and market value) Debt = $4B (book value and market value) Equity = $6B (book value and market value) The firm’s working capital needs are negligible, and they plan to continue to operate at their current capital structure. When do we use Method1 over Method2 Method1 ------------ FCFE = NI + NCC + INT(I - TR) - FC - WC - INT(1 - TR) + NB FCFE = 600 + 500 + 240 - 800 - 0 - 240 + 0 FCFE = 300 Method2 ------------ FCFE = NI - [(1 - DR)*(FC - DEP)] - [(1- DR)*(WC)] FCFE = 600 - [(1 - 0.4)*(800 - 500)] - [(1 - 0.4)*(0)] FCFE = 600 - 180 - 0.6*0 FCFE = 420
that’s interesting but I would go with method 1 b/c they don’t say 40% is the target DR. you put int in method 1 twice to F with us didn’t you?
FCFF = NI + NCC + INT(I - TR) - FC - WC FCFE = FCFF - INT(1 - T) + NB No? So just to be visible to everybody, I added and subtracted Int.
3_letters Wrote: ------------------------------------------------------- > that’s interesting but I would go with method 1 > b/c they don’t say 40% is the target DR. I went with Method-1 and you know what - Got slapped by ‘Kim Yang’ right across.
dinesh, Net Borrowing should’ve been 120 both methods give the same result
**Edit ^^ beat me to it again. They should be interchangeable. The NB would include a positive flow from the issue of new debt needed to maintain the current capital structure. Method 2 600 + 0.6*(500 - 800 + 0) = 420 Method 1 600 + 500 - 800 - 0 +120 = 420 The 120 being the portion of net capital spending funded by new debt to maintain 40/60 D/E 40% *(800-500) = 120 At least I think anyway.
also method 2 is used for forecasting FCFE, not so the case for method 1
ohh wow… I did’nt knew that. new capital needed = CAPEX - DEP = 800 - 500 = 300 This new capital will be financed with Debt so 0.40*300 = 120
umm yeah we should double check that though. something doesn’t feel right.
To keep the Debt ratio stable, a trick