A firm currently has sales per share of $10.00, and expects sales to grow by 25% next year. The net profit margin is expected to be 15%. Fixed capital investment net of depreciation is projected to be 65% of the sales increase, and working capital requirements are 15% of the projected sales increase. Debt will finance 45% of the investments in net capital and working capital. The company has an 11% required rate of return on equity. What is the firm’s expected free cash flow to equity (FCFE) per share next year under these assumptions? A) $0.77. B) $0.38. C) $1.88. Your answer: C was incorrect. The correct answer was A) $0.77. FCFE = net profit – NetFCInv – WCInv + DebtFin = $1.88 – $1.63 – 0.38 + 0.90 = 0.77 How do they get 1.88 for net profit? i thought it was 10 * 1.25 * .15?= 1.53?
10 * 1.25 * .15 = 1.88
DUH i’m so dumb. How about this one? The following information is derived from the financial records of Brown Company for the year ended December 31, 2004: Sales $3,400,000 Cost of Goods Sold (COGS) (2,100,000) Depreciation (300,000) Interest Paid (200,000) Gain on Sale of Old Equipment 400,000 Income Taxes Paid (300,000) Net Income $900,000 Brown issued bonds on June 30, 2004 and received proceeds of $4,000,000. Old equipment with a book value of $2,000,000 was sold on August 15, 2004 for $2,400,000 cash. Brown purchased land for a new factory on September 30, 2004 for $3,000,000, issuing a $2,000,000 note and paying the balance in cash. Using the definition of free cash flow to equity (FCFE) as cash flow from operations less capital expenditures, Brown’s free cash flow (FCF) available to equity shareholders for 2004 is: A) $2,200,000. B) $200,000. C) $6,200,000. Your answer: C was incorrect. The correct answer was A) $2,200,000. Brown’s cash flow from operations (CFO) was $800,000 = ($900,000 Net Income + $300,000 depreciation − $400,000 gain). Capital expenditure cash flows were −$1,000,000 for the factory and $2,400,000 cash received from sale of the old equipment for a net inflow of cash of $1,400,000. FCF available to shareholders was $2,200,000 = ($800,000 + $1,400,000). Note that in the case of the factory, the $2,000,000 that was financed using a mortgage note would not be part of the statement of cash flows (SCF), but would be included in the SCF notes. Why is the bonds not added back as per Net borrowing?
this one has been discussed FCFE = Net Income - (1-DR)*FCinv - (1-DR)*WcInv net profit margin = net income / sales sales1 = sales0*1.25 = 10*1.25 = 12.5 Net Income = 12.5*0.15 = 1.88 FCFE = 1.88 - (1-0.45)*(2.5*65) - (1-.45)*(2.5*.15) = 0.78
Key - again read the question: Using the definition of free cash flow to equity (FCFE) as cash flow from operations less capital expenditures
FCFE = net income + non-cash charges - FcInv - WcInv +Net borrowing or FCFE = CFO - Fcinv + net borrowing CFO = Net Income + Depreciation - Gain on Sale of Old equipment = 900,000 + 300,000 - 400,000 = 800K FcInv = Purchase - Cash from sale = 3,000,000 - 2,400,000 = 600,000 Net borrowing is 2,000,000 FCFE = 800K - 600K +2,000K = 2,200K
Ali… you are getting the same answer - but they are asking you to exclude the bond payable of 2000. CFO=900+300-400 = 800 CapEx = -1000 (Cash spent on Land) + 2400 (Proceeds from Sale) = 1400 FCFE = (By their request) CFO + Capex = 800 + 1400 = 2200
Aliman, i don’t think your FcINV is right. It should be 2.4 cash received - 1m cash paid = +1.4m. I believe what CPK is saying is that as per the definition used in the question stem, FCFE = CFO - FCINV, 800K+1.4million=2.2m
it is adhoc.
woops i didn’t see you posted before me. I guess my assumption was correct CPK?
awesome. thanks CPK!
It’s a good point, but to me they seem both correct. The net borrowing term handles the fact that you may use debt holder money to pay for expenditures, so I don’t think it’s a coincidence that it works out.
Under normal circumstances - your FCFE would have been an additional 4 Million more.