Reading 42- Free Cash Flow Valuation Schweser Book 4, Page 211 Calculation of FCFE when the firm maintains a target debt to asset ratio. Schweser gives the follwoing formulae: FCFE= NI- [(1-DR)*(FCInv- Dep)]- [(1-DR)*WCInv], where DR= target debt to asset ratio. I cant work out how this formulae is derived Heres my derivation: FCFE= NI+NCC-WCInv-FCInv+Net Borrowings Now since the debt to asset ratio for new investment in fixed capital and working capital is known; Net Borrowing(NB)= DR*(FCInv+WCInv) Now, FCFE= NI+NCC-WCInv-FCInv+NB => FCFE= NI+Dep- WCInv-FCInv+[DR*(FCInv+WCInv)] (assuming Dep is the only Non Cash Charge) => FCFE= NI+Dep-WCInv(1-DR)-FCInv(1-DR) Beyond this I am clueless. According to me this should be it. How is depreciation affected by the Target Debt Equit Ratio?
Net borrowings should be: debt ratio * ( NET working capital investment + NET fixed capital investment). Net fixed capital investment = FCInv - Depreciation. So, net borrowings will be debt ratio *(WC Inv + FCInv - Depreciation). FCFE = NI - (WCInv - Dep) - WCInv + DR *(WC Inv + FCInv - Depreciation) = NI- (1-DR)(WCINv-Dep)-(1-DR)WCInv
small correction to above: FCFE = NI - (WCInv - Dep) - WCInv + DR *(WC Inv + FCInv - Depreciation) = NI- (1-DR)(WCINv-Dep)-(1-DR)WCInv should instead read as FCFE = NI - (FCInv - Dep) - WCInv + DR *(WC Inv + FCInv - Depreciation) = NI- (1-DR)(FCINv-Dep)-(1-DR)WCInv
thanks for picking up the typo error 