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- AuthorPosts
- May 8, 2014 at 8:33 am #167864
Dear tutor,
Could you, please, clarify how we should calculate FCFE?
The matter is thatin BPP sudy text they give us the formula:
FCFE = Free cash flow
Less (net interest + net debt paid)
Add tax benefit from debt (net interest * tax rate)in Emile Woolf study text they give us the formula:
FCFE = Free cash flow
Less Interest paymentsTherefore three questions to you:
1. How should we treat net debt paid? Should it be accounted foe in the calculation?
2. How should we treat tax benefit on interest? Should it be accounted foe in the calculation?
3. Which interest should we take? Accrued or actually paid? Are any adjustments required if these two amounts differ from each other?Thank you in advance
May 8, 2014 at 3:25 pm #167927The real problem here is that there is more than one definition of Free cash flow, depending on the information available and who is ‘interested’.
Strictly it should really be the cash generated from operations (for the Statement of Cash flows) less increase in working capital less capital expenditure to maintain growth. This would end up with the total cash available for investors.
More commonly (in practice and in the exam) it is calculated as EBIT (1-t) less increase in working capital less capital expenditure (which is you think about it is not quite the same – for example, EBIT is after depreciation which is not a cash flow).
This is why you have seen two different formulae for FCFE. Here we want to end up with the cash available just to equity which means adjusting the FCF by payments to the debt lenders – the interest and any debt repayments.
So….to try and answer your questions:
1) any debt repaid should be accounting for when calculating FCFE
2) generally in the exam, do what Emile Woolf says and do not account for the tax benefit on the interest separately
3) Strictly, it should be interest paid (which strictly means adding back the interest expense and then subtracting the interest paid). However you would not be expected to adjust for that in the exam.I am sorry not to be able to simply give a rule. In the exam it is best to follow my answers to (1), (2) and (3) above unless there is something in the question specifically wanting different (which I do not think likely).
But also, do always state your assumptions. Not just here, but in all calculations, because provided your assumptions are sensible and your calculation ‘fits in’ with your assumptions, then you will get the marks. - AuthorPosts
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