Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which of the following components is NOT used in the computation of FCFE?

1. Cash flow from operating activities

2. Investment in fixed capital

3. Dividends paid

4. Net borrowing

The correct answer is: Dividends paid

Free Cash Flow to Equity (FCFE) measures the amount of cash available to equity shareholders after all expenses, reinvestment, and debt repayment have been accounted for. To compute FCFE, the following components are typically included: 1. Cash Flow from Operating Activities: This represents the cash generated from the normal business operations. It is a critical starting point because it reflects the company's ability to generate cash before capital expenditures and debt effects. 2. Investment in Fixed Capital: This includes capital expenditures necessary for maintaining or expanding the company's asset base. This deduction is essential as it reflects the cash outflows associated with investing in long-term assets essential for sustaining operational capacity. 3. Net Borrowing: This represents the net amount of debt issued or repaid and is included in the computation of FCFE as it affects the cash available to shareholders after meeting financing obligations. Dividends paid, however, do not form a part of the FCFE calculation. Instead, FCFE is calculated prior to the payment of dividends; thus, while dividends may influence decisions on how much cash can be returned to shareholders, they are not a component in the FCFE formula itself. FCFE is focused on cash flow available to equity holders, independent of dividends that are subsequently distributed