Ran across a question which asks you to use FCFF to calculate the Firm Value and then from there, the Equity Value.
One part of the question states “Phaneuf will finance 40 percent of the increase in net fixed assets (capital expenditures less depreciation) and 40 percent of the increase in working capital with debt financing.”
When subtracting the Debt Value (€1,800 million) from the Firm Value, the Debt Value did not include this [40% * net fixed assets + 40% * change in working capital.
Anyone have any idea why? The question also states that “The current market value of Phaneuf’s outstanding debt is €1,800 million.” I’m assuming the other new debt is already factored in to the €1,800 million?
In the FCFF-method financing is considered in the WACC (no need to consider additonal debt financing in the cash-flow calculation).
This WACC approach assumes a target D/E structure which reflects the future financing policy of the firm. In theory you could also use annual WACCs that take into account yearly changes in D/E ratios.
In bridging the EV to the EqV you then deduct the matket value of the current net debt position.
Note, if applied correctly as decribed above both methods, FCFF and FCFE should yield to the same EqV.
Appreciate the quick response Oscar. Just to confirm…
So overall when using FCFF, for the market values of debt and equity we should always reflect the current values/proportions and any changes to this capital structure are assumed to be factored in purely via changes to the marginal cost of debt?