FCFE - Free cash flow to equity
FCFF is the cash available to bond holders and stock holders after all expense and investments have taken place.
FCFE is the cash available to stock holders after all expense, investments and interest payments to debt-holders on an after tax basis.
What is difference between FCFF and FCFE ?
The difference is the interest payment in FCFE. In FCFE you subtract the interest expense from the cash flow to do valuations. FCFF shows the obligations for both stockholders as well as bondholders whereas FCFE consider only the obligations for stockholders.
Apart from the difference mentioned above, there are two more differences which are basically related to the approach that we will use while doing valuation. How do we calculate the FCFF and FCFE?
** FCFF can be calculated by using the formulae as mentioned below:-
FCFF = EBIT (1- t) + Depreciation/Amortization – Change in Non- Cash Working Capital – Capital Expenditure
Where,
EBIT = Earnings before income tax
t = Corporate tax rates
** FCFE can be calculated by using formula mentioned below,
FCFE = Net Income + Depreciation/Amortization – Change in Non- Cash Working Capital*(1-D) – Capital Expenditure*(1-D)
Where,
D = Debt ratio
Now, there lies two important points about these formulas, those are as follows:-
1) In FCFF, we use EBIT (1-t) whereas in FCFE, we use Net Income; this is because while using EBIT (1-t) in FCFF we do not consider the effect of interest payment as mentioned above.
2) IN FCFE, we use Change in Non-Cash Working Capital*(1-D) – Capital expenditure*(1-D) whereas in FCFF we use Change in Non-Cash Working Capital – Capital Expenditure. This is because in FCFE, we just want to concentrate on cash flow due to equity only.
To summarise:
Factors : FCFF
Cash Flows : Pre Debt Cash Flows
Expected Growth : Growth in Operating Income = Reinvestment rate * ROC
Discount Rate : WACC
Factors : FCFE
Cash Flows : post Debt Cash Flows
Expected Growth : Growth in Net Income = Retention ratio * ROE
Discount Rate : Cost of Equity
