## Wednesday, 29 February 2012

### Solving FCFE Questions - A technical point to ponder

FCFE from NI is calculated as follows

FCFE = NI + NCC + Net Borrowings - WCInv - FCInv

As you can see in the above formula there is no link of tax as Interest rate net of tax is added back to the FCFF but while calculating FCFE it is not included as FCFE are free cash flows available to equity investors. I encountered a question in which it was stated that the tax rate of investor is 35% and for me it was strange, I immediately thought that FCFE has nothing to do with tax so the question contains a trick. I solved it and to my surprise the answer was wrong. Later on reviewing the question I came to know that if the question states to use a different tax rate then in spite of starting from NI we should use Profit before tax (EBT) and then tax it to arrive at NI in order to calculate the FCFE. Later I thought it made sense but while I was solving the question I ignored this point and concluded incorrectly.

Moreover the WCInv and FCInv are two numbers which mostly require lengthy calculation as compared to the other values in calculating FCFE or FCFF. After solving a lot of questions I have concluded that when the question asks about calculating FCFE or FCFF then the first calculation should be done of WCInv and FCInv as other numbers are pretty straight forward and can be plugged into the calculator but these two, since require some calculations, if gathered early then arriving at FCFE and FCFF becomes easy.

I hope these will help you out. Equity is not only an area with high weight-age but it is also a high scoring area. I think ample practice can help in getting above 70 in this area and impacting the overall result positively.