Adjustment positive 3 million in calculating fcfe

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Adjustment : positive $3 million In calculating FCFE, only cash flow investments in fixed capital should be considered. The $7 million sale price of equipment is a cash inflow now available to equity holders and should be added to net income. However, the gain over book value that was realized when selling the equipment ($4 million) is already included in net income. Because the total sale is cash, not just the gain, the $3 million net book value must be added to net income. Therefore, the adjustment calculation is: $7 million in cash received – $4 million of gain recorded in net income = $3 million additional cash received added to net income to obtain FCFE. Note 3 : The decrease in long-term debt represents an unscheduled principal repayment; there was no new borrowing during the year. Adjustment : negative $5 million The unscheduled debt repayment cash flow (–$5 million) is an amount no longer available to equity holders and should be subtracted from net income to determine FCFE. Note 4 : On 1 January 2002, the company received cash from issuing 400,000 shares of common equity at a price of $25.00 per share. No adjustment Transactions between the firm and its shareholders do not affect FCFE. To calculate FCFE, therefore, no adjustment to net income is required with respect to the issuance of new shares. Note 5 : A new appraisal during the year increased the estimated market value of land held for investment by $2 million, which was not recognized in 2002 income. No adjustment The increased market value of the land did not generate any cash flow and was not reflected in net income. To calculate FCFE, therefore, no adjustment to net income is required. 18-14
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c. Free cash flow to equity (FCFE) is calculated as follows: FCFE = NI + NCC – FCINV – WCINV + Net Borrowing where NCC = non-cash charges FCINV = investment in fixed capital WCINV = investment in working capital Million $ Explanation NI = $30.16 From Exhibit 18B NCC = +$67.17 $71.17 (depreciation and amortization from Exhibit 18B) – $4.00* (gain on sale from Note 2) FCINV = –$68.00 $75.00 (capital expenditures from Note 1) – $7.00* (cash on sale from Note 2) WCINV = –$24.00 –$3.00 (increase in accounts receivable from Exhibit 18A + –$20.00 (increase in inventory from Exhibit 18A) + –$1.00 (decrease in accounts payable from Exhibit 18A) Net Borrowing = +(–$5.00) –$5.00 (decrease in long-term debt from Exhibit 18A) FCFE = $0.33 *Supplemental Note 2 in Exhibit 18C affects both NCC and FCINV. 24. Rio National’s equity is relatively undervalued compared to the industry on a P/E-to- growth (PEG) basis. Rio National’s PEG ratio of 1.33 is below the industry PEG ratio of 1.66. The lower PEG ratio is attractive because it implies that the growth rate at Rio National is available at a relatively lower price than is the case for the industry. The PEG ratios for Rio National and the industry are calculated below: Rio National Current Price = $25.00 Normalized Earnings per Share = $1.71 Price-to-Earnings Ratio = $25/$1.71 = 14.62 Growth Rate (as a percentage) = 11 PEG Ratio = 14.62/11 = 1.33 Industry Price-to-Earnings Ratio = 19.90 Growth Rate (as a percentage) = 12 PEG Ratio = 19.90/12 = 1.66 18-15
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