What Is Free Cash Flow to Equity (FCFE)?
Free cash flow to equity is a measure of how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid. FCFE is a measure of equity capital usage.
Understanding Free Cash Flow to Equity
Free cash flow to equity is composed of net income, capital expenditures, working capital, and debt. Net income is located on the company income statement. Capital expenditures can be found within the cash flows from the investing section on the cash flow statement.
Working capital is also found on the cash flow statement; however, it is in the cash flows from the operations section. In general, working capital represents the difference between the company’s most current assets and liabilities.
Key Takeaways
- A measure of equity cash usage, free cash flow to equity calculates how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid.
- Free cash flow to equity is composed of net income, capital expenditures, working capital, and debt.
- The FCFE metric is often used by analysts in an attempt to determine the value of a company.
- FCFE, as a method of valuation, gained popularity as an alternative to the dividend discount model (DDM), especially for cases in which a company does not pay a dividend.
These are short-term capital requirements related to immediate operations. Net borrowings can also be found on the cash flow statement in the cash flows from financing section. It is important to remember that interest expense is already included in net income so you do not need to add back interest expense.
The Formula for FCFE
FCFE=Cashfromoperations−Capex+Netdebtissued
What Does FCFE Tell You?
The FCFE metric is often used by analysts in an attempt to determine the value of a company. This method of valuation gained popularity as an alternative to the dividend discount model (DDM), especially if a company does not pay a dividend. Although FCFE may calculate the amount available to shareholders, it does not necessarily equate to the amount paid out to shareholders.
Analysts use FCFE to determine if dividend payments and stock repurchases are paid for with free cash flow to equity or some other form of financing. Investors want to see a dividend payment and share repurchase that is fully paid by FCFE.
If FCFE is less than the dividend payment and the cost to buy back shares, the company is funding with either debt or existing capital or issuing new securities. Existing capital includes retained earnings made in previous periods.
This is not what investors want to see in a current or prospective investment, even if interest rates are low. Some analysts argue that borrowing to pay for share repurchases when shares are trading at a discount, and rates are historically low is a good investment. However, this is only the case if the company's share price goes up in the future.
If the company's dividend payment funds are significantly less than the FCFE, then the firm is using the excess to increase its cash level or to invest in marketable securities. Finally, if the funds spent to buy back shares or pay dividends is approximately equal to the FCFE, then the firm is paying it all to its investors.
Example of How to Use FCFE
Using the Gordon Growth Model, the FCFE is used to calculate the value of equity using this formula:
Vequity=(r−g)FCFE
Where:
- Vequity= value of the stock today
- FCFE = expected FCFE for next year
- r =cost of equityof the firm
- g = growth rate in FCFE for the firm
This model is used to find the value of the equity claim of a company and is only appropriate to use if capital expenditure is not significantly greater than depreciation and if the beta of the company's stock is close to 1 or below 1.
FAQs
FCFE is calculated as Net Income + Depreciation and Amortization (D&A) – Change in Net Working Capital – Capital Expenditures (Capex) + Net Borrowing. FCFE represents the cash flow available to equity investors, and is thereby a levered metric, since non-equity claims were met.
What is the difference between FCF and FCFE? ›
FCF is calculated by subtracting net income from operating activities from net investments in working capital. FCFE is calculated by subtracting interest expense and net income tax expense from FCFF, and then adding back in net debt issuance.
How to calculate terminal value of free cash flow to equity? ›
TV = (FCFn x (1 + g)) / (WACC – g)
- TV = terminal value.
- FCF = free cash flow.
- n = year 1 of terminal period or final year.
- g = perpetual growth rate of FCF.
- WACC = weighted average cost of capital.
Calculating Free Cash Flow in Excel
Enter "Total Cash Flow From Operating Activities" into cell A3, "Capital Expenditures" into cell A4, and "Free Cash Flow" into cell A5. Then, enter "=80670000000" into cell B3 and "=7310000000" into cell B4. To calculate Apple's FCF, enter the formula "=B3-B4" into cell B5.
What is the 2 stage FCFE model? ›
The 2-stage FCFE sums the present values of FCFE in the high growth phase and stable growth phase to arrive at the value of the firm.
How do you calculate FCFE from FCF? ›
FCFF = EBIT(1 – Tax rate) + Dep – FCInv – WCInv. FCFF = EBITDA(1 – Tax rate) + Dep(Tax rate) – FCInv – WCInv. FCFE can then be found by using FCFE = FCFF – Int(1 – Tax rate) + Net borrowing.
What is the FCFE formula? ›
Free cash flow to equity (FCFE) is the amount of cash a business generates that is available to be potentially distributed to shareholders. It is calculated as Cash from Operations less Capital Expenditures plus net debt issued.
What is a good free cash flow ratio? ›
A “good” free cash flow conversion rate would typically be consistently around or above 100%, as it indicates efficient working capital management. If the FCF conversion rate of a company is in excess of 100%, that implies operational efficiency.
How do I choose FCFF or FCFE? ›
FCFE is designed to estimate the cash flow that's available to equity holders, whereas FCFF takes into account both debt and equity holders. Additionally, FCFE assumes that a company doesn't issue or retire any debt, while FCFF doesn't make this assumption and considers a company's capital structure.
What is the formula for calculating free cash flow? ›
Free cash flow = sales revenue – (operating costs + taxes) – investments needed in operating capital. Free cash flow = total operating profit with taxes – total investment in operating capital.
The fundamental concept of the H-Model is that it illustrates the relationship between free cash flows, discount rate (WACC), and high and low growth rates. This method assumes that the company is expected to earn excess returns over a high growth period and will eventually decline linearly to a stable low growth rate.
What are the 2 models of equity valuation? ›
Three major categories of equity valuation models are present value, multiplier, and asset-based valuation models. Present value models estimate value as the present value of expected future benefits. Multiplier models estimate intrinsic value based on a multiple of some fundamental variable.
What is the difference between 2 stage and 3 stage DCF? ›
The first stage may have the companies grow at unearthly speeds of 50%, 100% or 200% a year. The second stage could have the companies grow at more earthly rates of 15%, 20% or even 30%. The third stage could have the growth rates decline steadily to terminal or horizon stage growth rates.
What is the difference between free cash flow and equity cash flow? ›
The most significant difference compared to FCFE is that FCFF considers both equity (shareholders) and debt providers. Compared to calculating the free cash flow, there is only one difference: we add the interest–corrected for the tax advantage–back to the net profit and thus get the cash flow for all investors.
Is unlevered free cash flow the same as FCFE? ›
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.
What is the difference between FCFF and FCFE reconciliation? ›
The FCFF method subtracts debt at the very end to arrive at the intrinsic value of equity, whereas the FCFE method integrates interest payments and net additions to debt to arrive at FCFE.
What is the difference between FCF and DCF? ›
Discounted Cash Flow (DCF) is an analysis method use to value a business. It estimates the revenues that a company will generate by calculating free cash flow (FCF) and the net present value of this FCF.
