I have a general question conering the difference between FCFF and FCFE. The formula to arrive from FCFF to FCFE is: FCFE= FCFF - (interest * (1-tax rate)) + net borrowing why is borrowing added. i thought to arrive to FCFE we have to substract debt. i know its net borrowing, but is not so logic to me. thanks for your help!
pls help! i just really want to understand the concept!
Because FCFE is FCF that is available to the shareholders. Think about this in terms of say a company that doesn’t want to cut dividends so it borrows funds to pay them, i.e. the borrowed funds are available to the equity holders.
Schweser says to stop thinking in a complicated financial statment frame of mind and think of the company as a cash processor. Cash comes into the company from sales and revenues. The company takes this $$$ and applies it first to pay salaries and other operating expenses (not interest). It also takes the $$ and buys new printers, machines (WC inv) and maybe even a new building (FC inv). Either way, after the cash from their revenues is spent on operating expenses, WCinv (printers), and FCinv (buildings) what you have left is Free Cash Flow to the Firm. So now they have cash to send to their capital providers. Capital can be provided by bondholders or stockholders so you can send cash to either of these fellas. Since common stock is lowest on the totem pole and gets paid last, FCFF first goes to pay Interest Payments to Bondholders. BUT, they can also take this opportunity to borrow more from their bondholders (net borrowing). This option with the bondholders is the difference between FCFF and FCFE. The net result from the payments and borrowing is applied to FCFF to arrive at FCFE. You have FCFF. FCFF-interest pmts to bond holders (1-t)+ net borrowing (if they wanna borrow more= FCFE
great thanx - you rock!
thanx with an “x”? is that what they are teaching you young kids today? Lemme guess, 22-24?jk!