In the mock question 40, it asks to calculate the value of equity using the estimates provided. I assumed this would use the forecast of FCFE formula below. However, it simply used the whole FCInv amount to subtract from CFO. The DR ratio was provided earlier in the question with debt as 30% of total assets. This was confusing and I got the answer wrong, but because of a misunderstanding/application rather than not knowing how to calculate in the two methods.
= NI - ((1-DR) * WCInv) - ((1-DR) * FCInv-Dep) + New borrowing
Can someone help explain why you would not use this formula when calculating FCFE from CFO? Was this purposely designed to mislead and trick us up?
Also, when projecting future years by the growth rate, the final FCFE calculated (then used to to calc future years’ FCFE) includes the one year FCInv and new borrowing provided. Growing this figure inclusive of those one year assumptions assumes those investments are still components of future years’ FCFE? The question does not explicitly say that the FCInv and future borrowing will occur each year. It specifically says “in 20xx”.
Regarding your point 1, no need to apply that formula. You are already given CFO, which adjusts NCWC, and you just have to reduce Total FCinvestment because you are adding debt borrowings seperately. One thing to note here is that we do not know much of WC investment would be required this year to arrive at Debt allocated to those WC. But i think as if they have not mentioned WC additional requirements, its safe to assume no increase/decrease in WC.
Regarding your point 2, i thought exactly what you think. It makes no sense to assume same level of FCInv and borrowing would continue in perpetuity, I tried solving in both ways and ended up marking one of the options which are correct. Ideally for future years only CFO should be extrapolated based on growth to arrive at terminal year value.
Cant do anything, we have to live with this. I hope they will be very clear in exam to avoid wasting our time on this shit things.
Just use the CFO - FCInv + Net Borrowing formula… CFO is given in the exhibit under the 2nd row of the column. Also the question says using exhibit 4 so I wouldnt start pulling any numbers from other exhibits in the vignette.
I would assume the same! Although in the mock PM the question said using Exhibit 1 for calculating the return based on such sensitivies, but it used the ER and data from Exhibit 2 to get there… 95% of the time though, I agree.
that is the exact question – why is the forecast using DR not being used in this question. it uses the full amount. I think we have gotten to the bottom of this, Chintan said it best. can’t go reaching for other data that isn’t given, but also hopefully they are more explicit so we don’t use a proportion of FC or WC funded by equity, vs. the whole FCInv/WCinv… and vice versa.