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    FCFE Vs DCFF Module 8 (Class 28)

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    Vineet Agarwal
    There are two types of free cash flow (FCF): free cash flow to firm (FCFF) and free cash flow to equity (FCFE). FCFF excludes interest expense and debt changes, while FCFE includes them. FCFF uses enterprise value and WACC in valuations, while FCFE uses equity value and cost of equity. FCFF belongs to both debt and equity investors, while FCFE belongs only to equity investors. The key difference is whether interest expense and debt changes are included or excluded from the cash flow.

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    FCFE Vs DCFF Module 8 (Class 28)

    Uploaded by

    Vineet Agarwal
    74 views9 pages
    There are two types of free cash flow (FCF): free cash flow to firm (FCFF) and free cash flow to equity (FCFE). FCFF excludes interest expense and debt changes, while FCFE includes them. FCFF uses enterprise value and WACC in valuations, while FCFE uses equity value and cost of equity. FCFF belongs to both debt and equity investors, while FCFE belongs only to equity investors. The key difference is whether interest expense and debt changes are included or excluded from the cash flow.

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    There are two types of free cash flow (FCF): free cash flow to firm (FCFF) and free cash flow to equity (FCFE). FCFF excludes interest expense and debt changes, while FCFE includes them. FCFF uses enterprise value and WACC in valuations, while FCFE uses equity value and cost of equity. FCFF belongs to both debt and equity investors, while FCFE belongs only to equity investors. The key difference is whether interest expense and debt changes are included or excluded from the cash flow.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    74 views9 pages

    FCFE Vs DCFF Module 8 (Class 28)

    Uploaded by

    Vineet Agarwal
    There are two types of free cash flow (FCF): free cash flow to firm (FCFF) and free cash flow to equity (FCFE). FCFF excludes interest expense and debt changes, while FCFE includes them. FCFF uses enterprise value and WACC in valuations, while FCFE uses equity value and cost of equity. FCFF belongs to both debt and equity investors, while FCFE belongs only to equity investors. The key difference is whether interest expense and debt changes are included or excluded from the cash flow.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 9

    FCFE Vs DCFF

    Module 8
    FCFF VS FCFE

    What is Free Cash Flow?

    • Free Cash Flow is the amount of cash flow a firm generates (net of taxes) after
    taking into account non-cash expenses, changes in operating assets and liabilities,
    and capital expenditures.

    • Free Cash Flow is a more accurate metric than EBITDA, EBIT, and Net Income as they
    leave out large capital expenditures and change in cash due to changes in operating
    assets and liabilities. Also, metrics such as EBIT and Net Income include non-cash
    expenses, further misrepresenting the true cash flow of a business.

    • Due to the reasons mentioned above, Free Cash Flow is often used in a DCF analysis
    and therefore, a clearer understanding of the concept is important for finance
    interviews, especially for Investment Banking and Corporate Finance roles.
    FCFF VS FCFE

    Types of Free Cash Flow

    There are two types of Free Cash Flows:


    • Free Cash Flow to Firm (FCFF) (also referred to as Unlevered Free Cash Flow) and
    • Free Cash Flow to Equity (FCFE), commonly referred to as Levered Free Cash Flow.

    It is important to understand the difference between FCFF vs FCFE as the discount rate
    and numerator of valuation multiples depend on the type of cash flow used.

    Difference between FCFF VS FCFE

    The key difference between Unlevered Free Cash Flow and Levered Free Cash Flow is
    that Unlevered Free Cash Flow excludes the impact of interest expense and net debt
    issuance (repayments) whereas Levered Free Cash Flow includes the impact of interest
    expense and net debt issuance (repayments).
    FCFF VS FCFE
    FCFF VS FCFE
    FCFF VS FCFE

    How to Calculate Unlevered Free Cash Flow

    • EBIT * (1-Tax Rate) + Non-Cash Expenses – Changes in Operating Assets & Liabilities –
    CapEx
    • Cash Flow from Operations + Tax Adjusted Interest Expense – CapEx
    • Net Income + Tax Adjusted Interest Expense + Non-Cash Expenses – Changes in
    Operating Assets & Liabilities – CapEx

    How to Calculate Levered Free Cash Flow

    Net Income + Non-Cash Charges – Changes in Operating Assets & Liabilities – CapEx +
    Net Debt Issued (Repaid)
    Cash Flow from Operations – CapEx + Net Debt Issued (Repaid)
    FCFF VS FCFE
    Valuation Multiples: FCFF VS FCFE

    • While calculating valuation multiples, we often use either Enterprise Value or Equity
    Value in the numerator with some cash flow metric in the denominator.

    • If the denominator includes interest expense, Equity Value is used, and if it does not
    include interest expense, Enterprise Value is used.

    • Therefore, Equity Value is used with Levered Free Cash Flow and Enterprise Value is
    used with Unlevered Free Cash Flow.

    • Enterprise Value is used with Unlevered Free Cash Flows because this type of cash flow
    belongs to both debt and equity investors.

    • However, Equity Value is used with Levered Free Cash Flow as Levered Free Cash Flow
    includes the impact of interest expense and mandatory debt repayments, and
    therefore belongs to only equity investors.

    • Similarly, if EBIT is in the denominator, Enterprise Value would be used in the


    numerator and if Net Income is in the denominator, Equity Value would be used in the
    numerator.
    FCFF VS FCFE

    Discount Rate: FCFF vs FCFE

    • If Unlevered Free Cash Flows are being used, the firm’s Weighted Average Cost of
    Capital (WACC) is used as the discount rate because one must take into account the
    entire capital structure of the company. Calculating Enterprise Value means including
    the share of all investors.

    • If Levered Free Cash Flows are used, the firm’s Cost of Equity should be used as the
    discount rate because it involves only the amount left for equity investors. It ensures
    calculating Equity Value instead of Enterprise Value.
    FCFF VS FCFE

    Estimation of different inputs of FCFF Valuation

    How do we estimate the different inputs that go into FCFF valuation?

    • FCFF = EBIT(1-t) – (capital expenditures – depreciation) – (change in noncash working


    capital)
    • The growth rate in EBIT = Reinvestment rate * Return on capital (ROC)

    Where:
    • Reinvestment rate =
    {(capital expenditures – depreciation) +(change in noncash working capital)} ÷ {EBIT(1-t)}
    • ROC = {EBIT(1-t)} ÷ {BV of debt + BV of equity}
    • The discount rate is the WACC = We*Ke + Wd*Kd(*1-t)
    • The terminal value = {EBITn+1(1-t)(1-Reinvestment rate)} ÷ (WACCn – stable gowth rate}

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