FCFE

CFA Level III
#1

Scheswer Vol. 2 (2009), PM, Answer 15.6 This might be pretty basic, but I am not getting it for some reason. Question is asking: "Calculation of FCFE will lead to a valuation of the S&P that most likely is: A. Too low if CE is +ve B. Too low if Change in WC is +ve C. too low if proceeds from new debt issues exceed principal debt repayments I chose C which was correct. Explanation given: It says: “NI + dep - Change in WC - CE - Principle Debt repayments + Proceeds from new debt issues = FCFE. (This I understand). Then it goes on to say:” formula will underestimate FCFE if proceeds from new debt issues exceeds principal debt replayments (how?). The other choices A&B will cause the formula to overestimate FCFE (how?). I thought it would be the other way around.

#2

Wasn’t there another part to the question - the analyst is using formula as follows: FCFE = NI + Dep Therefore if Proceeds from debt > repayments this + amount would not be in his calculation so he would have underestimated FCFE Same logic for the other 2 points

#3

Seems wrong to me too. If new debt issues > debt repayments, FCFE will be higher, not understated.

#4

grgkir001 Wrote: ------------------------------------------------------- > Wasn’t there another part to the question - the > analyst is using formula as follows: > FCFE = NI + Dep > > Therefore if Proceeds from debt > repayments this > + amount would not be in his calculation so he > would have underestimated FCFE > > Same logic for the other 2 points just checked and you are correct, so the answer is correct as given by Schweser

#5

Thanks grg, you are right that the question says the analyst is using that particular formula. But isnt that the wrong formula anyway? FCFE is not just the NI + Dep. I was looking at it from the perspective of the whole formula. Why would schweser give us a wrong formula and use that to work out the problem?

#6

no it’s saying if he calculates FCFE using his formula will he over-/underestimate it when compared to using the correct formula. so HIS calculation would be: if CE is positive - he would not have accounted for CE so his FCFE would be too high because he wouldn’t have deducted it if change in WC is positive - he ouwld not have deducted this from FCFE so his FCFE would be higher if proceeds from new debt > repayments - he would not have added this so his would be too low. Options per question: A. Too low if CE is +ve B. Too low if Change in WC is +ve C. too low if proceeds from new debt issues exceed principal debt repayments So C is the only one that fits…make more sense?

#7

u da man grg…thanks !!