• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer
Finance Train

Finance Train

High Quality tutorials for finance, risk, data science

  • Home
  • Data Science
  • CFA® Exam
  • PRM Exam
  • Tutorials
  • Careers
  • Products
  • Login

How to Calculate FCFF and FCFE

Equity Analysis

To value a company, one of the most popular methods is to use the discounted cash flow method. Traditionally, the dividends paid by the company are used as a proxy for the cash flows of the business. However, the dividends do not truly reflect the amount of cash flow the business can generate for its shareholders.

Many analysts, instead of dividends, use alternative measures of cash flow such as FCFF and FCFE.

Free Cash Flow to Firm (FCFF)

FCFF is the cash flow generated by the firm before debt payment but after reinvestment needs and taxes. FCFF helps in estimating the value of the entire firm, by discounting the projected FCFF by the weighted average cost of capital (WACC).

FCFF is the cash flow available to the suppliers of capital after all operating expenses (including taxes) are paid and working and fixed capital investments are made. It is calculated by making the following adjustments to EBIT.

FCFF = EBIT – Taxes + Depreciation (non-cash costs) – Capital spending – Increase in net working capital – Change in other assets + Terminal value

Free Cash Flow to Equity (FCFE)

FCFE is the cash flow after taxes, reinvestment needs, and debt cash flows. Using FCFE, one can directly calculate the value of equity by discounting the projected FCFE by the cost of equity. It is the cash flow available after all operating expenses, interest, and principle repayments have been made and necessary investments in working capital and fixed capital have been made. It can be calculated as follows:

FCFE = EBIT – interest – taxes + depreciation (non-cash costs) – capital expenditures – increase in net working capital – principal debt repayments + new debt issues + terminal value

Note that if we already have FCFF, we can use the value of FCFF to calculate FCFE as follows:

FCFE = FCFF – Interest expense * (1 – tax) + Increase in debt

Valuation Using FCFE and FCFF

Using the Gordon Growth Mode, the value of the firm and equity can be calculated as follows:

VFirm = FCFF/(WACC – g)

VEquity = VFirm – Value of debt

Alternatively, value of equity can directly be calculated as follows:

VEquity = FCFE/(Cost of Equity – g)

This is the value of just the equity claim of the business. Note that while using FCFF, the growth needs to be considered in operating income and FCFF. However, when using FCFE, growth in equity income and FCFE is considered. Also note that the discount rate is WACC when using FCFF and it is just cost of equity when using FCFE.

Join Our Facebook Group - Finance, Risk and Data Science

Posts You May Like

How to Improve your Financial Health

CFA® Exam Overview and Guidelines (Updated for 2021)

Changing Themes (Look and Feel) in ggplot2 in R

Coordinates in ggplot2 in R

Facets for ggplot2 Charts in R (Faceting Layer)

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Primary Sidebar

Latest Tutorials

    • Data Visualization with R
    • Derivatives with R
    • Machine Learning in Finance Using Python
    • Credit Risk Modelling in R
    • Quantitative Trading Strategies in R
    • Financial Time Series Analysis in R
    • VaR Mapping
    • Option Valuation
    • Financial Reporting Standards
    • Fraud
Facebook Group

Membership

Unlock full access to Finance Train and see the entire library of member-only content and resources.

Subscribe

Footer

Recent Posts

  • How to Improve your Financial Health
  • CFA® Exam Overview and Guidelines (Updated for 2021)
  • Changing Themes (Look and Feel) in ggplot2 in R
  • Coordinates in ggplot2 in R
  • Facets for ggplot2 Charts in R (Faceting Layer)

Products

  • Level I Authority for CFA® Exam
  • CFA Level I Practice Questions
  • CFA Level I Mock Exam
  • Level II Question Bank for CFA® Exam
  • PRM Exam 1 Practice Question Bank
  • All Products

Quick Links

  • Privacy Policy
  • Contact Us

CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

Copyright © 2021 Finance Train. All rights reserved.

  • About Us
  • Privacy Policy
  • Contact Us