FCFE formula

CFA Level II Equities
#1

I came across a problem that gives a bunch of per share numbers (EPS, depriation per share, capex per share…) and then asks for the FCFE calc…I have basically memorized the formula but I’m curious if I can make a bit more sense of it…can someone shed some light on why we apply the equity weighting (from the target D/E ratio given) as we do below? I undestand by we’d need to weight it at the end but how come we start with EPS And then subtract the WEIGHTED difference between depreciation and capex per share?

FCFE year 0 = Earnings per share − [(Capital Expenditures − Depreciation) × (1 − Debt Ratio)] − [(Change in working capital) × (1 − Debt Ratio)

***why can’t I just do 'EPS + Depreciation - CAPEX - working capital? … and then just take this answer and multiply by the % equity?

Sorry for the wordiness and thanks!

#2

simply because the (1-Debt Ratio) does not apply to the EPS.

If you did

EPS - (CapEx - Depr - Change in WC) *[1-DR) --> you would be ok.

But you are now doing EPS * (1-DR) – which is not part of the original formula.

You are also multiplying the EPS by a factor - that should never be applied there.

#3

That’s helpful…I think I’m confusing myself- wanting to do the simple addition and subtraction before even thinking about brining in the cap structure…very helpful though thanks!