FCFF for Leveraged Firms?

CFA Level II Equities
#1

It is said that FCFF is better for valuating firms that are highly leveraged (compared to other methods). Why is this so?

#2

Maybe they mean compared to FCFE?

  1. FCFF better because it uses WACC, and WACC would be less sensitive to changes in capital structure resulting from leverage because only a portion is affected (it also considers the affects of debt) so you’d get less volatile fluctuations perhaps

  2. FCFF represents CF to debt and equity holders…

  3. FCFE would actually change if you incorporated new debt because it includes net borrowing whereas FCFF does not

  4. It also incorporates interest tax shield which is a real gain that companies receive. Without the interest tax shield there would be no difference between a levered and unlevered company (MM1)

#3

Need to use FCFF when highly leveraged (as mentioned) because you are likely to have negative FCFE.

Also use FCFF when a company has a changing capital structure because, as explained above, it will be less impacted by the change.