FCFE,Amortization, Deferred

Taxes, ROE and ROC

Prof. Manoj Rathore
 FCFE – Calculate Free Cash Flow to Equity
(Formula, Example)
• In corporate finance, free cash flow to
equity (FCFE) is a metric of how
much cash can be distributed to
the equityshareholders of the company as
dividends or stock buybacks—after all
expenses, reinvestments, and debt
repayments are taken care of.
FCFE FORMULA

FCFE FORMULA STARTING WITH NET INCOME

 
FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC +
Capex + Net Borrowings

FCFE FORMULA STARTING FROM EBIT

FCFE Formula = EBIT – Interest – Taxes + Depreciation & Amortization +

Changes in WC + Capex + Net Borrowings

FCFE FORMULA STARTING FROM FCFF ( FREE CASH FLOW AVAILABLE TO FIRM)

FCFE Formula = FCFF – [ Interest x (1-tax)]  + Net Borrowings

CALCULATE FCFE FOR 2016
FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC +
Capex + Net Borrowings
1) FIND THE NET INCOME
Net Income is provided in the example = $168
2) FIND DEPRECIATION & AMORTIZATION
Depreciation & Amortization is provided in the Income Statement. We need to add
the 2016 Depreciation figure = $150
3) Changes in Working Capital
Increase in Cash – Increase in Current Asset + Increase in Current Liability ( $15-
$90+$0) = -$75
4) CAPITAL EXPENDITURE
Capital Expenditure = change in Gross Property Plant and Equipment (Gross PPE) =
$1200 – $900 = $300.
Please note that this is a Cash impact will be an outflow of 300
5) NET BORROWINGS
Borrowings will include of both the short term and long term debt
Short Term Debt = $60 – $30 = $30
Long Term Debt = $342 – $300 = $42
Total Net Borrowings = $30 + $42 = $72
FCFE FOR 2016 COMES OUT TO BE AS PER BELOW –
Amortization
In accounting, amortization refers to the periodic expensing of the value of an intangible asset
. Similar to depreciation of tangible assets, intangible assets are typically expensed over the
course of the asset’s useful life. It represents reduction in value of the intangible asset
 (Trademarks,Patents,Copyrights,Brand names,Goodwill,Other intellectual property.),
due to usage or obsolescence. Basically, intangible assets decrease in value over time, and
amortization is the method of accounting for that decrease in valueover the course of the
asset’s useful life. A company’s long-term capital expenditures can also be amortized over
time.

Amortization Treatment
Intangible assets are recorded on the balance sheet. But over time, as you amortize these 
assets, the amortized amount accumulates in a contra-asset account. Therefore, it diminishes
the net value of the intangible assets. The periodic amortization amounts are expensed on
the income statement as incurred. Whereas on the cash flow statement, these expenses are
added back to net income in the operating section. This is because they represent non-cash 
expenses.

R&D investment is an investment in the long-term cash flow generation of the company,

and as such should be capitalized, not expensed. ... The capitalized R&D would
be amortized over the same set of years,
A deferred tax liability is a tax that is assessed or is due for the current period
but has not yet been paid. 

Example of Deferred Tax Asset and Liability

DTA – Say Book profit of an entity before taxes is Rs. 1000 and this includes
provision for bad debts of Rs.200. For the purpose of tax profit, bad debts will
be allowed in future when it’s actually written off. Hence taxable income after
this disallowance will be Rs. 1200 and let’s say income tax rate is 20% then the
entity will pay taxes on Rs. 1200 i.e (1200*20%) Rs. 240.
If bad debts were not disallowed, entity would have paid tax on Rs. 1000 i.e
(1000*20%) Rs 200. For the additional Rs. 40 which is already paid now, we
have to create DTA. Entry for recording DTA is as under:
Deferred Tax Asset Dr                    40
To Deferred Tax Expense Cr        40
(Being DTA of Rs. 40 accounted in the books)
DTL – Common example of DTL would be depreciation. When the 
depreciation rate per Income tax act is higher than the depreciation rate per
companies act (generally in the initial years), entity will end up paying less tax
for the current period. This will create deferred tax liability in the books.
Calculating Return on Equity (ROE)
Return on equity measures a company's profit as a percentage of the
combined total worth of all ownership interests in the company. For
example, if a company's profit equals $10 million for a period, and the total
value of the shareholders' equity interests in the company equals $100
million, the return on equity would equal 10% ($10 million divided by $100
million).

Calculating Return on Capital (ROC)

Return on capital, in addition to using the value of ownership interests in a
company, also includes the total value of debts owed by the company in the
form of loans and bonds.
For example, if a company's profit equals $10 million for a period, and the
total value of the shareholders' equity interests in the company equals $100
million, and debts equal $100 million, the return on capital equals 5%
($10 million divided by $200 million).
THANK YOU