In: Finance
Consider the following information:
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
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.