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CFA Level I · CFA Level I Exam · Analyzing Statements of Cash Flows II

Compared with a firm whose FCFE is steady, a firm that funds a large share of new capital expenditures by issuing debt will most likely report:

Debt-funded capital expenditure will most likely produce higher FCFE, because FCFE includes net borrowing as an addition. The investment outflow is offset by debt proceeds, leaving more cash available to equity holders at that point, though future interest will reduce later FCFE.

  1. Alower FCFE because borrowing is a financing outflow
  2. Bhigher FCFE because net borrowing is added in the calculationCorrect
  3. Cunchanged FCFE because debt proceeds offset interest exactly

Explanation

FCFE equals FCFF less after-tax interest plus net borrowing, so debt-funded capital expenditures are offset by positive net borrowing and FCFE is higher than for a firm funding the same investment from internal cash. Borrowing proceeds are inflows, not outflows, and they do not offset interest exactly.

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