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Lesson 6 of 9 · 15 min
Asset and financing models: investment, financing needs and FCFE
The asset model sets how much the company must invest to support its revenue, and the financing model decides where the money comes from or goes to, which is what turns a forecast of profits into a forecast of FCFE.
In short
- Asset models can grow assets with revenue (constant turnover), use a regression of asset growth on revenue growth, or compare asset and revenue CAGRs; regressions are weaker than for costs because assets are bought before the revenue arrives.
- Grow a balance sheet line only if it is operating and involves cash; do not grow non-operating assets (marketable securities) or market-value changes (a goodwill impairment).
- Financing needs = Δoperating assets − Δnon-debt liabilities − Δretained earnings. Positive: raise cash, debt or equity. Negative: a surplus to hold as cash, repay debt or return to shareholders.
- FCFE = NI − (Δgross LT assets − Dep) − ΔWC + Δdebt Δcash + dividends + repurchases − issuance.
- Dividends raise financing needs; planned borrowing lowers them and raises FCFE. FCFF depends on profit and investment, so it is much less sensitive to the financing choice.
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