CFA Level II ExamEquity InvestmentsMedium
A financial analyst is valuing a company using the free cash flow to equity (FCFE) model. The company has a current net income of $50 million, depreciation of $10 million, capital expenditures of $20 million, and an increase in working capital of $5 million. The company has no debt and does not plan to issue or repurchase any equity. What is the current FCFE for this company?
- A$55 million
- B$45 million
- C$35 million
- D$40 million
Show answer & explanationAnswer & explanation
Correct answer: C. $35 million
FCFE can be calculated as Net Income + Depreciation - Capital Expenditures - Change in Working Capital. In this case, FCFE = $50 million + $10 million - $20 million - $5 million = $35 million. Since there is no net borrowing or repayment, and no equity issuance/repurchase, these components are zero.
Why the other options are wrong
- A. Incorrect calculation.
- B. Incorrect calculation.
- D. Incorrect calculation.
Free Cash Flow to Equity (FCFE) Calculation
The calculation of FCFE starting from net income, adjusting for non-cash items, investment in fixed capital, and investment in working capital, and considering net borrowing.
- FCFE = Net Income + Depreciation - Capital Expenditures - ΔWorking Capital + Net Borrowing.
- Represents cash flow available to equity holders.
- Alternative formula: FCFF - Net Debt Payments + Net Borrowings.
Memory trick: Net Income, Add Dep, Subtract Capex & WC change.