Chapter 3 – Free Cash Flow Valuation
Solutions
1.
$100 increase in:
Change in FCFF
Change in FCFE
A. Net income
+100
+100
B. Cash operating expenses
–60
–60
C. Depreciation
+40
+40
D. Interest expense
0
–60
E. EBIT
+60
+60
F. Accounts receivable
–100
–100
G. Accounts payable
+100
+100
H. Property, plant, and equipment
–100
–100
I. Notes payable
0
+100
J. Cash dividends paid
0
0
K. Shares issued
0
0
L. Share repurchases
0
0
2.
A.
Free cash flow to the firm, found with Equation 37, is
FCFF = NI + NCC + Int(1 – Tax rate) – FCInv – WCInv
FCFF = 285 + 180 + 130(1 – 0.40) – 349 – (39 + 44 – 22 – 23)
FCFF = 285 + 180 + 78 – 349 – 38 = $156 million
B.
Free cash flow to equity, found with Equation 310, is
FCFE = NI + NCC – FCInv – WCInv + Net borrowing
FCFE = 285 + 180 – 349 – (39 + 44 – 22 – 23) + (10 + 40)
FCFE = 285 + 180 – 349 – 38 + 50 = $128 million
C.
To find FCFE from FCFF, use the relationship in Equation 39
FCFE = FCFF – Int(1 – Tax rate) + Net borrowing
FCFE = 156 – 130(1 – 0.40) + (10 + 40)
FCFE = 156 – 78 + 50 = $128 million
3.
A.
To find FCFF from CFO, EBIT, or EBITDA, the analyst can use
Equations 38, 312, and 313.
To get FCFF from CFO:
FCFF = CFO + Int(1 – Tax rate) – FCInv
FCFF = 427 + 130(1 – 0.40) – 349 = 427 + 78 – 349 = $156 million
To get FCFF from EBIT:
FCFF = EBIT(1 – Tax rate) + Dep – FCInv – WCInv
FCFF = 605(1 – 0.40) + 180 – 349 – 38
FCFF = 363 + 180 – 349 – 38 = $156 million
Finally, to obtain FCFF from EBITDA:
FCFF = EBITDA(1 – Tax rate) + Dep(Tax rate) – FCInv – WCInv
1
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View Full DocumentFCFF = 785(1 – 0.40) + 180(0.40) – 349 – 38
FCFF = 471 + 72 – 349 – 38 = $156 million
B.
The simplest approach is to calculate FCFF from CFO, EBIT, or EBITDA
as was done in Part A above, and then to find FCFE by making the
appropriate adjustments to FCFF:
FCFE = FCFF – Int(1 – Tax rate) + Net borrowing.
FCFE = 156 – 130(1 – 0.40) + 50 = 156 – 78 + 50 = $128 million
You can also find FCFE using CFO, EBIT, or EBITDA directly.
Starting
with CFO, using Equation 311, FCFE is
FCFE = CFO – FCInv + Net borrowing
FCFE = 427 – 349 + 50 = $128 million
Starting with EBIT, FCFE (found with an equation derived in Footnote 9)
is
FCFE = EBIT(1 – Tax rate) + Dep – Int(1 – Tax rate) – FCInv –
WCInv + Net borrowing
FCFE = 605(1 – 0.40) + 180 – 130(1 – 0.40) – 349 – 38 + 50
FCFE = 363 +180 – 78 – 349 – 38 + 50 = $128 million
Finally, starting with EBITDA, FCFE (found with an equation derived in
Footnote 9) is
FCFE = EBITDA(1 – Tax rate) + Dep(Tax rate) – Int(1 – Tax rate) –
FCInv – WCInv + Net borrowing
FCFE = 785(1 – 0.40) + 180(0.40) – 130(1 – 0.40) – 349 – 38 + 50
FCFE = 471 + 72 – 78 – 349 – 38 + 50 = $128 million
4
A.
FCF = Net income + Depreciation and amortization – Cash dividends –
Capital expenditures.
This definition of FCF is sometimes used to
determine how much “discretionary” cash flow management has at its
disposal.
Management discretion concerning dividends is limited by
investor expectations that dividends will be maintained.
Comparing this
definition with Equation 37,
FCFF = NI + NCC + Int(1 – Tax rate) – FCInv – WCInv
FCFF includes a reduction for investments in working capital and the
addition of aftertax interest expense.
Common stock dividends are not
subtracted from FCFF because doing so represents a distribution of the
cash
available
to investors.
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 Winter '07
 YAXUAN
 Interest, Net Present Value, Valuation, Generally Accepted Accounting Principles, FCFE

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