# Reading 41, q's 6 and 7 CFAI text

I don’t understand number 6. When calculating the NCC-FCInv-NWCInv portion of the FCFE, they multiplied that section by the amount that was equity (.80). In the very next question, we calulate FCFE and the only time that the debt percentage is relevant is for the calculation of Net Borrowing This is frustrating me. In grad school and in this I have never used a debt percentage against the capex, working capital, and depreciation. Whats the deal?

had posted this on another post yesterday… see if it helps you understand the concept This method applies to a company that is mature - hence there is a target debt ratio. Once company is mature - the amount spent on FCInv and WCInv would be kind of maintenance investments. For FCInv - this is over and above depreciation. Assume that FCInv = Amount spent for new maintenance investment. So since the Depreciation amount is returned back to you FCInv - Depr is what you actually spent on the FCInv. Similarly WCInv is what was spent on the WC portion. These would be debt financed to the extent of the Debt Ratio. So in your original equation: FCFE = NI + Depr -FCInv - WCInv + Net Borrowing. = NI + Depr - FCInv - WCInv + DR(FCInv-Depr) + DR (WCInv) Parts which DR(FCInv-Depr) + DR (WCInv) = Total Net Borrowing. Simplifying: FCFE = NI - 1-DR CP

Why is it used here and in no other case? The very next question doesn’t use the debt ratio.

q7 -> clearly says 40% of increase in fixed assets (cap ex. less depr) and 40% of WC will be financed with debt. so needs to be used here. q6: 20% of investment in assets will be financed with debt… it says so you have to use it. q8 is a FCFF related question - so there debt does not matter.

cpk123 Wrote: ------------------------------------------------------- > q7 -> clearly says 40% of increase in fixed assets > (cap ex. less depr) and 40% of WC will be financed > with debt. > so needs to be used here. > > q6: 20% of investment in assets will be financed > with debt… > > it says so you have to use it. > > q8 is a FCFF related question - so there debt does > not matter. Forgive me for pounding this, but in question 7, calculating FCFE, the “40%” is only applicable in the calculation of net borrowing, according to the answer. In the answer, it is not multiplied through FC, DEP, and NWC like it is in question 6. See the bottom of page 451. It just shows the 40% being used to calc net borrowings even though the base question wording is highly similar to number 6 - why the difference and when do we know to do one versus the other? 6 is FCFE = NI - (1-DR)(Capex- Depr) -(1-DR)(WC) 7 Is FCFE = NI +DEPR - CAPEX -WC + (DR)(CAPEX-DEPR+WC) Its two majorly different things…

> > 6 is > > FCFE = NI - (1-DR)(Capex- Depr) -(1-DR)(WC) > > 7 Is > > FCFE = NI +DEPR - CAPEX -WC + (DR)(CAPEX-DEPR+WC) > > > Its two majorly different things… It is the same equation. 7 has been expanded from 6.

OhhhhhhhhKaaaaayy… I finally get it…theyre the inverse of each other…in number 6 it mulltiplies through by .80, but its just the same as adding back in the .20 after +NCC-FCINV-NWCINV… 6 and 7 are showing two methods that are two sides of the same coin…the numbers work out the same… Whew - though I was missing something new…

Thanks Guys Rolo