If depreciation increases by $100, FCFF = NI + NCC + Int(1-t) - FCinv -WCinv, increases by $100(0.40) = $40, assuming 40% tax. If interest increases by $100, what’s the impact on FCFF and FCFE? … got me the first time.
FCFF is not affected because we add back the after tax interest expense. FCFE is lower by 60.
Issuing of shares does not impact neither FCFF nor FCFE, that’s what they say in the book. However, if you look at problem 6, page 435 of Equity, they say because FCinv and WCinv are financed 20% by debt, the are financed 80% by equity…then they go on to adjust FCFE by 80%. I don’t get it. If issuing stock does not factor into FCFE, why include that in the calculation?
They are not adjusting the share issuance there they are using the (1-DR) variant of the FCFE Formula and accounting for the Net Borrowing figure… NI + Depr - FCInv - WCInv + DR(FcInv - Depr + WcInv) = NI - (1-DR) ( FCInv - Depr + WcInv) since DR=0.2, 1-DR=0.8
so what would dr=0.2 translate to in terms of d/e? im soo lost
I didn’t know about this variant of FCFE before! Thanks. In the solution they make it more difficult than it should be as they use 1-DR (0.80), etc. It’s now straightforward, replace net borrowing in the FCFE formula by DR(FCinv - Depr + WCinv)). For year 2009: NI + Depr - FCInv - WCInv + DR(FcInv - Depr + WcInv) 1.76 + 0.495-1.92-0.33+0.20 (1.92-0.495+0.33) = 0.356
DR=0.2 or D/(D+E) = 0.2 So 1/(1+D/E) = 0.2 1+D/E = 1/0.2 = 5 D/E = 4
In the first post, if depreciation increases by 100, shouldn’t FCFF increase by 100 too? Not 100(1-0.4) like you said…
Take an example… always helps Sales = 1000 Depr = 100 No other expenses. NI = (1000-100) * (1-0.4) = 540 FCFF = FCFE = 540 + 100 = 640 Now Depr + 100 = 200 NI = (1000-200) * (1-0.4) = 480 FCFF = FCFE = 480 + 200 = 680 So FCFF and FCFE went UP 40 = 100 * 0.4
Had made a mistake DR=0.2 or D/(D+E) = 0.2 So 1/(1+D/E) = 0.2 1+E/D = 1/0.2 = 5 E/D = 4 D/E = 0.25
CP, why r u saying if DR = 0.2 then D/E = 0.25. IS DR not already the debt to equity ratio. Please let us clarify this urgently
> In the first post, if depreciation increases by 100, shouldn’t FCFF increase by 100 too? Not 100(1-0.4) like you said… Yes, it does go up by $100 because we always add dpreciation back, but in addition when depreciation goes up by $100, your NI gets hurt by 0.40 x $100, so subtract that.
debt ratio DR = debt (d) divided by total capital (d+e) while d/e is just that! it is similar to mark-up and margin, one can easily be converted to the other.
janakisiri clarified this somewhere else. If Debt ratio = 0.25, then D/E = 0.25/0.75 = 1/3 If Debt ratio = 0.30, then D/E = 0.3/0.7 = 0.429 If Debt ratio = 0.5, then D/E = 0.5/0.5 = 1.0 If Debt ratio = 0.95, then D/E = 0.95/0.05 = 19 etc If D/E = 0.25/0.75, then Debt ratio = 0.25 If D/E = 25/75, then Debt ratio = 0.25 If D/E = 40/60, then Debt ratio = 0.40