Hello,
I am having trouble distinguishing when to use the FCFE equation = NI - [(CAPEX - Depr) * (1 - DA)] - (WC * (1-DA))
vs the FCFE equation = FCFF - (Int * (1-t)) + Net Borrowing
Is the debt to asset one used when forecasting FCFE and the second equation I listed used for determining the actual FCFE in a certain period?
Or is the rule of thumb to just use the Debt to asset equation whenever the Debt to asset ratio is given?
Thank you!
Hey there,
So the logic behind using the debt ratio is when the management has actually specified the percentage of capex and wc that would be debt funded. And it is used to forecast fcfe (if debt ratio is provided in a question). To dig deep on this for better understanding, when calculating fcfe normally (i.e without inclusion of debt ratio), we add net borrowings to the equation in order to offset capex and wc funded by debt when subtract them from net income. Remember, fcfe is cash only to investors and hence we need to include stuff only funded by investors and not debt.
The second equation u mentioned is the calculation of fcfe from fcff which you’re supposed to know along with other methods. Deduct interest(cash flow to lenders) from Ebit and add back net borrowings to offset inclusion of debt in wc and capex(already included in fcff).
Hope this helps.
I believe they mention this in the books somewhere … recalling from several years ago.
The DR is a number derived by looking at the “history” of the amount of Depreciation and the amount of borrowing the company has made.
For this number to be “fairly” constant - (to be used for prediction) - the company must be in a stable life cycle stage - where they are not excessively taking on extra debt or spending more money on buying new PP&E. The DR then is a “maintenance” kind of expense.