A firm issues a senior debt in year1
he increase in net borrowing will cause the FCFE to increase in th year
but why does next yr’s FCFE decrease because of higher interest expense?
FCFE = NI + NCC - WCInv - FCInv + Net Borrowing
so why does the FCFE decrease I thhe future years?
The interest expense’s effect on NI is offset by the Net borrowing effect yr1.
Year 2, the interest expense will still decrease NI but there is not new Net Borrowing to offset it.
Tq!
so it’s the lower NI n no change to FCFF
Higher interest makes NI lower by Int(1 − t), so in the future FCFE will be lower.
Note that neither borrowing nor interest has an effect on FCFF: net borrowing doesn’t appear in the formula, and adding Int(1 − t) cancels out the interest expense in NI.