FCFF and FCFE - Reading 40 Question

CFA Level II
#1

Hey guys,

Did someone get to Reading 40? I am looking at Question 1, Reading 40, Page 328 and completely blank on sub-questions C, D, I and K.

“Indicate the effect on this period’s FCFF and FCFE of a change in each of the items listed here. Assume a $100 increase in each case and a 40 perc tax rate”

C) Depreciation

D)Interest Expense

I) Notes PAyable

k) Proceeds from issuing new common shares

Answers:

C) FCFF +40 FCFE +40

D) FCFF 0 FCFE -60

I) FCFF - 0 FCFE +100

K) FCFF 0 FCFE 0

Thank you very much!

#2

To Add, In calculation of FCFE in Question 2, why do we ADD 40? If cash flows show as -10 and -40 doesnt it mean that we repaid debt? Thus new borrowing 0-40 repayment, shouldn’t it be -40???

#3

Depreciation: this is a non-cash expense so the only impact it has on cashflow is by reducing your taxable income (and therefore, your tax bill). So more depreciation will result in less taxes, therefore more cashflow. For all the others, remember that FCFF is the cashflow available to both debtholders and shareholders. FCFE is the cashflow available to shareholders (ie, after new borrowings have been received from debtholders, and debt and interest has been repaid). Are you sure you wrote the ‘interest expense’ answer correctly, i would have thought that it would increase FCFF by $60.