net borrowing calculation of FCFE question

CFA Level II
#1

hi all, i am referring to reading 35 question 13, question A’s calculation treatment of its net borrowing

based on the statement, it says

Current liabilities (all non-interest-bearing) was 57 in 2007, 141 in 2008, then it said Long-term debt is 0 for both years.In the answer EOC didnt add any net borrowing back to the calculation equation. I am confused, how do we know there is no debt from the total liability increase as indicated in the total current liabilities? when we talk about net borrowing, I thought we just find the different in total current liabilities?

#2

The key here is “non-interest bearing”. This is the clue that there are no “Net Borrowings” in Current Liabilities. “Net Borrowings” in the context of FCFE vs. FCFF implies an interest component that must go to the Lenders and is not available to Equity holders.

So by giving the clue of “non-interest bearing” you can safely conclude that there is no debt creating an interest expense that must go to debtholders before Equity owners can get their take.

#3

Not to put too fine a point on it, but current liabilities _ can _ bear interest.

And, of course, some long-term liabilities do not bear interest.

#4

Not too fine of a point at all; I suspect the author of the question indeed was in part testing this.

#5

ahhhhhh, so for working capital, we deducte the interest bearing part, for net borrowing, we only count the interest bearing part

I sort of understand why we take the interest bearing part for working capital, but not really, can someone explain this in more detail about this to me?

#6

We’re trying to get to activities that generate cash that can be paid to the shareholders.

An increase in wages payable doesn’t really _ generate _ cash. (What it does is not use cash.) Similarly with an increase in accounts payable, or interest payable, or other non-interest-bearing current liabilities.

(Note: the one non-interest-bearing liability whose change probably _ should _ be included in FCFE is unearned revenue (customer deposits): when that increases, it does generate cash. Oh, well.)

#7

Thanks!

#8

You’re welcome.