Calculate free cash flow to equity, Financial Accounting

(a)  In order to obtain free cash flow to equity (FCFE), the two adjustments that Shaar must make to cash flow from operations (CFO) are

 i.   CFO does not consider the investing activities in long-term assets, especially the plant and equipment investments. All cash flows corresponding to those necessary investments are not available to stock holders and hence this must be subtracted from CFO in order to obtain FCFE.

 ii. CFO also does not account for the amount of capital supplied to the firm by debt holders or bond investors. The new borrowings, net of debt repayment, are cash flows which are available to stock holders and hence must be added to CFO to arrive at FCFE.

(b)  Let us look into each of the five supplemental notes one by one

Note 1: Rio National had $75 million in capital expenditures during the year.

Net Negative Adjustment: negative $75 million

The cash flows required for capital expenditures (-$75 million) are not available to the stockholders and must be subtracted from net income to get FCFE.

Note 2: A piece of equipment that was originally purchased for $10 million was sold for $7 million at year-end, when it had a net book value of $3 million. Equipment sales are unusual for Rio National.

Net Positive Adjustment: positive $3 million

In determining FCFE, only cash flow investments in fixed capital should be accounted. The selling price of equipment ($7 million) is a cash inflow currently available to stockholders and should be added to net income. But the gain over book value that was realized during the equipment sale ($4 million) is already included in the net income. Since the total sale is cash, the $3 million net book value must also be added to net income in addition to the gain. Therefore, the adjustment calculation is as follows $7 million cash received - $4 million gain recorded in net income = $3 million additional cash received added to net income to obtain FCFE.

Note 3: The decrease in long-term debt represents an unscheduled principal repayment; there was no new borrowing during the year.

Net Negative Adjustment: negative $5 million

The unscheduled debt repayment cash flow ($240 million - $245 million = -$5 million) is an amount not available to stockholders and must be subtracted from net income to get FCFE.

Note 4: On 1 January 2002, the company received cash from issuing 400,000 shares of common equity at a price of $25.00 per share.

No adjustment

Transactions between the firm and its shareholders do not have an effect on FCFE. Therefore, no adjustment to net income is required with respect to the issuance of new shares to get FCFE.

Note 5: A new appraisal during the year increased the estimated market value of land held for investment by $2 million, which was not recognized in 2002 income.

No adjustment

The increased market value of the land did not generate any cash flow and was not reflected in net income. Only when there is a real cash transaction involved, this will affect net income and hence FCFE. Hence no adjustment to net income is required to determine FCFE.

(c)   Rio National's Free cash flow to equity (FCFE) is calculated as follows:

FCFE = NI + NCC - FCINV - WCINV + Net Borrowing

Where NI - net income

NCC - non-cash charges

FCINV - investment in fixed capital

WCINV - investment in working capital

Calculation:

NCC = depreciation & amortization - gain on sale of equipment (note 2) = $71.17 - $4 = $67.17

FCINV = Capital expenditures (note 1) - cash on sale (note 2) = $75 - $7 = $68

WCINV = Increase in accounts receivable + Increase in inventory + decrease in accounts payable

                = ($30 - $27) + ($209.06 - $189.06) + ($26.05 - $25.05) = $24

Net borrowing = decrease in long-term debt = $240 - $245 = -$5

Hence FCFE = $30.16 + $67.17 - $68 - $24 + (-$5) = $0.33

Thus Rio National's free cash flow to equity for the year 2002 was determined to be $0.33 million.

Posted Date: 3/22/2013 5:14:31 AM | Location : United States







Related Discussions:- Calculate free cash flow to equity, Assignment Help, Ask Question on Calculate free cash flow to equity, Get Answer, Expert's Help, Calculate free cash flow to equity Discussions

Write discussion on Calculate free cash flow to equity
Your posts are moderated
Related Questions
Q. What do you mean by depreciation? What are the causes for depreciation? Explain the two methods of depreciation. Depreciation means a fall in the quality, quantity or value o

For several firms trade payables - suppliers of goods and services - represent the major component of current liabilities the amounts owed by the company which have to be repaid wi

On July 1, 2010, Spear Co. issued 1,000 of its 10%, $1,000 bonds at 99 plus accrued interest. The bonds are dated April 1, 2010 and mature on April 1, 2020. Interest is payable sem


You have recently been promoted to assistant audit manager in SHAUNA & Co, a firm of Chartered Certified Accountants. Your first assignment in this new role is to supervise the aud

Motivation is said to be an internal state that energises an individual to engage in certain types of behaviours. This process is triggered when the individual experiences certain

Suppose you are a financial manager of Yuen Cheong Manufacturng Company. Due to the rising demand of product X, Yuen Cheong Manufacturng Company decides to open a new production pl

Distribution to a beneficiary Before distribution to a beneficiary, the investments will be re-valued and the profits or losses divided between the beneficiaries as follows:-

The appropriate treatment of Cash flow in respect of the following items as per US GAAP & FASB - (230-10)  1. Receipt of Insurance settlement proceeds of $2 mill. From an intern

(a)  In order to obtain free cash flow to equity (FCFE), the two adjustments that Shaar must make to cash flow from operations (CFO) are  i.   CFO does not consider the inves