- CFA Exams
- CFA Level I Exam
- Study Session 11. Equity Valuation (3)
- Reading 28. Free Cash Flow Valuation
- Subject 2. Computing FCFF and FCFE from net income, EBIT, EBITDA, or CFO
CFA Practice Question
Assume a 30% tax rate and a $100 increase in notes payable, this period's FCFF will ______ and FCFE will ______.
A. not change; not change.
B. not change; increase by $100.
C. increase by $100; increase by $100.
Explanation: FCFF is not affected by changes in notes payable (net borrowing). However, as FCFE = FCFF + Net borrowing - Int ( 1- Tax rate), FCFE will increase by $100.
User Contributed Comments 7
| User | Comment |
|---|---|
| danlan2 | Notes payable does not affect interest expense? |
| RNAN | Isn't Notes Payable part of Working Capital? |
| RNAN | Yes, I checked the notes (LOS 12:B:b) and it clearly states that Notes Payable is part of WCInv for the purpose of calculating FCF. Does anyone else agree with me that the answer given is incorrect? Answer C seems to be correct. |
| volkovv | I disagree, cash and current portion of debt should be excluded from working capital for the purpose of calculating FCF for valuation purposes. In case of FCFE change in short term debt (notes payable) and change in long term debt is added as 'Net Borrowing' since this is additional money available to shareholders. |
| mchu | WCInv=(Inv+A/R)-(A/P) |
| dblueroom | RNAN - Note payable is not part of working capital. you were probably thinking about accounts payable. |
| akirchner1 | From the CFA book: Although working capital (WC) is often defined as current assets minus current liabilities, WC for cash flow and valuation purposes is defined to exclude cash and short term debt (which includes notes payable and the current portion of long-term debt. |