Question

Why is net borrowings added to the FCFE equation?

Why is net borrowings added to the FCFE equation?

Homework Answers

Answer #1

FCFF = NI + Interest(1-t) + depreciation - FCinvestment - WCinvestment
FCFE = NI +Depreciation - FCInvestment - WCInvestment + Net borrowings

In FCFF we have to deduct all fixed capital investment and change in working capital because we have to calculate free cash to the firm(after deducting all capital expenditure). But,
When we have to calculate FCFE we have added back the borrowings because we have to calculate free cash flow to the equity not to the firm. Company issue new debt and payout proceeds as dividend.
Added Net borrowings because the amount isused by directors for investment but out or even paying dividend to shareholdes.

Net Borrowings = New Debt - repayment of old debt

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