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“Understand the Difference- FCFF

and FCFE”
FCFF is actually the cash available to bond holders and stock holders after all expense
and investments have taken place whereas FCFE is the cash available to stock holders after
all expense, investments and interest payments to debt-holders on an after tax basis.

Hence the basic difference lies because of consideration of interest payment in FCFE i.e. 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

FCFE consider only the obligations for stockholders.

Apart from the difference mentioned above and in my last post about FCFF and FCFE, there lies
some more difference which is basically related to approach that we will use while doing valuation.
( Will discuss in details in my later post)

Now, the question is 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

Whereas 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 we just want to concentrate on cash flow due to equity only.

up Bottom-up These factors are of no use until you know about the assumptions you must take while calculating EV through FCFF and FCFE methods. . Hence. the art of valuations lie in your understanding about these factors and its uses which I will explain later.Factors FCFF FCFE Cash Flows Pre Debt Cash Flows (already post Debt Cash Flows (already mentioned above) mentioned above) Expected Growth Growth in Operating Income = Growth in Net Income Reinvestment rate * ROC = Retention ratio * ROE Discount Rate WACC Cost of Equity Beta Bottom.