Chartered Financial Analyst (CFA) Level 1 Practice Exam

To calculate FFO to debt, which equation is used?

1. FFO / Total debt

2. (CFO - Capital expenditures) / Total Debt

3. (FFO - Dividends) / Capital Expenditures

4. EBITDA / average outstanding common shares

The correct answer is: FFO / Total debt

The formula for calculating Funds From Operations (FFO) to debt is indeed FFO divided by total debt. FFO is a critical measure, particularly used in the real estate sector, as it effectively captures the cash generated from operating activities by adjusting net income for non-cash items, such as depreciation and amortization, as well as excluding gains or losses from property sales. This metric provides a clearer picture of a company's operational performance and its ability to cover its debt obligations. By dividing FFO by total debt, you assess how well a company’s operational cash flow (after accounting for necessary expenses) can cover its debt. This ratio is important for investors and analysts as it indicates the financial health of a company and its ability to meet long-term obligations while ensuring it can sustain its operations. Using total debt in the denominator highlights the proportion of cash flow available to service debt obligations, measuring leverage and risk. The other options listed involve different calculations that do not align with the specific goal of assessing the relationship between funds from operations and debt levels. For example, some options relate to cash flow or capital expenditures, which are not relevant in this context for measuring FFO to debt.