In a debt model, how should you treat net borrowings when calculating FCFE?

• A. Net borrowings are ignored
• B. Net borrowings reduce FCFE
• C. Net borrowings add to FCFE
• D. Net borrowings are the same as debt repayments

Answer: (C)

When valuing equity with FCFE, the amount available to shareholders after all obligations is influenced by financing activity. Net borrowings represent new money the company borrows minus repayments, and this inflow increases the cash that can be returned to shareholders through dividends or buybacks after funding investments and operations. Therefore, net borrowings are added to FCFE because they expand the cash available to equity holders.

If you ignored net borrowings, you’d miss the financing impact that increases cash to equity in periods of net debt issuance. Conversely, treating net borrowings as a reduction would misstate FCFE, since it’s the net amount of borrowing (issuances minus repayments) that matters, not just the repayments. Debt repayments alone reduce FCFE, but net borrowings capture the overall effect.