FCFE

CFA Level II
#1

I dont understand the concept of :

FCFE = NI - (1-DE Ratio)(FCI-Dep) - (1-DE Ratio)(WCI)

I understand FCFE = NI - (FCI-Dep)-WCI

But what is the logic behind using the debt/equity ratios?

#2

Are you sure that is the right equation?

It doesnt seem right.

FCFE is free cash flow to equity

#3

Yes, I am sure. Without calculating the net borrowings, we can calculate FCFE using this formula.

However, I fail to understand how the formula is derived. That is what I want to understand.

#4

The idea here is to calculate your Net Borrowing as the amount of FCInv and WCInv financed by debt (which is available to equity). By using the DR you are assuming that the company finances itself with a target or constant capital structure.

So:

FCFE = NI − (FCInv − Dep) − WCInv + Net borrowing

Net borrowing = DR (FCInv − Dep) + DR (WCInv)

FCFE = NI − (FCInv − Dep) − WCInv + (DR)(FCInv − Dep) + (DR)(WCInv)

FCFE = NI − (1 − DR)(FCInv − Dep) − (1 − DR)(WCInv)

#5

Interesting… Looks like it is just a reshuffling of the following formula:

FCFE = NI - (1 - DR)(FCInv - Dep) - (1 - DR)(WCInv)

FCFE = NI - (FCInv - DEP - DRFCInv + DRDep) - (WCInv - DRWCInv)

FCFE = NI - FCInv +DEP + DRFCInv - DRDep - WCInv + DRWCInv

FCFE = NI + (Depreciation - (DR x Dep)) - (FCInv + (DR FCInv)) - (WCInv + (DR x WCINv))

Interesting, it doesnt match the equation below. Any ideas why?

FCFE = NI + Depreciation - WCInv - FCInv + Net Borrowing

#6

FCFE = NI + Dep - WCInv - FCInv + (+DRFCInv - DRDep + DRWCInv)

FCFE = NI + Depreciation - WCInv - FCInv + Net Borrowing

Makes sense, that portion is "Net Borrowing

#7

Fcfe= ni - (1-dr)(fc+wc-dep)

#8

Is it (1-DR) or (1 - DE)?

#9

DR; Debt as a percentage of debt plus equity

#10

That makes sense… Thanks

#11

I don’t understand why are we deducting dep from FCinv cause,
FCinv = net closing PPE - net opening PPE + dep

#12

Which equation are you referring to.

Also
Oopening PPE = $800
Closing PPE = $1000
Depr for year = $100
FCInv (assuming no sale of assets) = $300

Start at $800. Assuming no purchases closing should be opening minus dper = $800 - $100 = $700.
But closing was $1000. Therefore FCinv = $300

your equation:

FCinv = net closing PPE - net opening PPE + dep
FCInv = $1000 - $800 + $100 = $100

should be
FCinv = net closing PPE - net opening PPE - dep
FCInv = $1000 - $800 - $100 = $300

1 Like
#13

I was referring to,
FCFE = NI + dep - (1-DR)(FCinv - dep) - (1-DR)(WCinv)
But I got the logic that we’re only considering net cash we spent for fixed cost investment