CFA Level II ExamFinancial Statement AnalysisMedium
A financial analyst is modeling the Free Cash Flow to Equity (FCFE) for 'Tech Solutions Inc.' for the upcoming year. The company's net income is projected to be $100 million. Depreciation is $20 million, capital expenditures are $30 million, and the increase in working capital is $10 million. Tech Solutions Inc. has no debt. What is the projected FCFE for the upcoming year?
- A$90 million
- B$110 million
- C$80 million
- D$100 million
Show answer & explanationAnswer & explanation
Correct answer: C. $80 million
FCFE can be calculated as Net Income + Depreciation - Capital Expenditures - Increase in Working Capital + Net Borrowing. Since there is no debt, Net Borrowing is zero. FCFE = $100M + $20M - $30M - $10M = $80M.
Why the other options are wrong
- A. This would be the result if working capital was incorrectly added or ignored.
- B. This would be the result if depreciation was subtracted instead of added, or if working capital was added instead of subtracted.
- D. This would be the result if depreciation was ignored and only CapEx and working capital were subtracted, or if only net income was considered.
FCFE from Net Income
Free Cash Flow to Equity (FCFE) represents the cash flow available to equity holders after all expenses and reinvestment needs have been met.
- Formula: FCFE = Net Income + Non-cash Charges - Investment in Working Capital - Investment in Fixed Capital + Net Borrowing.
- Non-cash charges typically include depreciation and amortization.
- Investment in fixed capital is usually capital expenditures (CapEx).
- Net borrowing is the net change in debt (new debt issued - debt repaid).
Memory trick: Net Income's Cash Flow, Add Back Non-Cash, Subtract Growth's Dash, Debt's No Crash.