Question

In: Finance

Consider the following information: Cash and cash equivalents at 31 December 2010 = $1.50 million Cash...

Consider the following information:

  • Cash and cash equivalents at 31 December 2010 = $1.50 million
  • Cash and cash equivalents at 31 December 2011 = $1.85 million
  • Interest expense = $0.48 million
  • Net borrowings = $0.25 million
  • Cash dividends = $1.25 million

Given a tax rate of 40%, the firm's FCFF at the end of 2011 is closest to:

Select one:

a. $1,830,000

b. $1,638,000

c. $388,000

Question 13

Question text

Assuming a tax rate of 40%, a $100 increase in which of the following would not impact FCFF and decrease FCFE by $60?

Select one:

a. Notes payable

b. Interest expense

c. Accounts payable

Question 14

Question text

How do net income and EBITDA, respectively, rate as proxies for cash flows in the FCFE and FCFF formulas?

Select one:

a. Good

b. No use

c. Poor

Solutions

Expert Solution

12). Answer: B

FCFF = Increases in cash balances + After-tax interest expense + Repayment of principal - New borrowings + Cash dividends + Share repurchases - New equity issues

FCFF = ($1.85m – $1.50m) + [$0.48m × (1 - 0.4)] - $0.25m + $1.25m = $1.638 million

13). Correct Option : B

A $100 increase in notes payable will have no impact on FCFF but increase FCFE by $100.

A $100 increase in interest expense will have no impact on FCFF but decrease FCFE by $60.

A $100 increase in accounts payable will increase FCFF and FCFE by $100

14). Poor: Option "C"

Net income is a poor proxy for FCFE. We can see that by simply examining the formula for FCFE in terms of NI.

FCFE = NI + NCC – FCInv – WCInv + net borrowing

Net income includes non-cash charges like depreciation that have to be added back to arrive at FCFE. In addition, it ignores cash flows that don’t appear on the income statement, such as investments in working capital and fixed assets as well as net borrowings.

EBITDA is a poor proxy for FCFF. We can also see this from the formula relating FCFF to EBITDA

FCFF = [EBITDA × (1 – tax rate)] + (Dep × tax rate) – FCInv – WCInv

EBITDA doesn’t reflect the cash taxes paid by the firm, and it ignores the cash flow effects of the investments in working capital and fixed capital.


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