Cash flow props

CFA Level II Equities
#1

Hey folks,

Wondering if someone can clear this up for me…couldn’t find any answers online or in previous threads.

I’m doing multi-method valuation and had just prepared FCFF for discounting when something started bugging my mind… When calculating the yearly cash movements for a firm why do I use FCFE and not the sum of the cash from operations, cash from investing and cash from financing? FCFE includes debt financing but not equity financing… In other words, why are movements in equity not included in cash flow movements when they do in fact provide liquidity - for example through the issuance of equity?

Hope someone can put this analysts head to rest…

Many thanks,
BD Elliot

#2

What kind of question is this ? FCFE does include cash flow to equity only. It is after providing for the debt providers

#3

One that you didn’t understand… I’m not asking what FCFE is and consists of but rather why cash flow balances are calculated using FCFE and NOT FCF that also covers equity movements?

#4

Hard to believe you passed your Level II with such conceptual error You mean to say you are not sure how FCFE is balanced against equity and not FCF ?

#5

FCFE is what’s available to equity holders - so operating cf + investing cf + the debt element of the financing cf. My questions is why FCFE (given that equity movements are not included in this number) is used to calculate end cash balances.

Here’s an example:

Op CF: +100
Investing CF: -50
Financing CF - Debt: +50
Financing CF - Equity: +100

FCFE = 100-50+50 = 100

Beg. cash balance: 50
Net change in cash: 100 (FCFE is used)
End. cash balance: 150

Why is FCFE used for net change in cash, when it doesn’t include the 100 from equity issuance?

#6

You are mixing the two:

  1. In a waterfall structure FCFE is an organic flow. It is what accrues to the EXISTING shareholders after servicing the debt and repaying the debt. If FCF is 0 or negative after servicing (or/and repayment) the debt providers then nothing accrues to the equity providers and on the contrary the stakes will need be diluted to meet up the debt servicing. This will render a negative FCFE ( and hence negative Net cash balance at the end of the period)

  2. Issuance of equity is a contra account to the authorised share capital without affecting the net cash balance( It is an accounting treatment). So all other things remaining same if $100 worth of equity is issued the same is immediately diluted at cost.

Hope things are clear now

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