Can some please explain to me FCFE and FCFF. Also, is there a way to remember this long equation…?
FCFF is the cash flow that will be available for distribution to the firms stockholders as well as debtholders. On the other hand FCFE is the cash flow that will be available to the Equity Holders only. To remember the formulas first remember Cash Flow from Operations (CFO)=Net Income + Non Cash Charges - Working Capital Investments so, FCFF=CFO + [Interest Expense(1-tax)]-Capital Expenditure FCFE=CFO - Capital Expenditure + Net Debt Let me try to explain the critical elements. 1. Since FCFF looks at cash flow to both stockholders and bondholders, we need to add the interest paid to the bondholders. However we lose the tax savings. 2. Net Debt= New Debt Issued-Debt Repayment. So if you have issued more new debt than you have repaid back then you now have more money that can be disbursed to the stockholders. 3. Capital Expenditure is the money spend on acquiring fixed assets and is thus an outflow (generally to sustain the existing level of production). Please correct me if I am wrong.
This is correct, although I never understood why they add net debt to FCFE and not FCFF. That money is available to debtholders too, think of a revolving credit line that gets used to repay short term borrowings, or even longer term borrowings with low balances for that matter.
in my opinion… FCFF = NI + NCC + DEBT INTEREST(1-TAX) - FCinv - WCinv or = CFO + DEBT INTEREST(1-TAX) - FCinv. FCFE = CFO + NET BORROWINGS - FCinv. if the co. is reporting under IFRS, it may not adjust debt interest for FCFF since interest paid may be reported under financing cash outflow. nevertheless, if for IRFS, dividends paid can also be a part of operating cash outflows so we would need to add dividends paid to FCFF bt there aint no need to adjust them for tax since dividends paid are tax deductible. correct me if any1 disagrees…
markCFAIL Wrote: ------------------------------------------------------- > This is correct, although I never understood why > they add net debt to FCFE and not FCFF. That > money is available to debtholders too, think of a > revolving credit line that gets used to repay > short term borrowings, or even longer term > borrowings with low balances for that matter. Mark - think of it this way - the only money available to your creditors is the payment that is due to them. So, if I make my required payments, and then go borrow more money, the creditors have no claim on it as they have already been satisfied. Obviously down the road, you have to pay it back, but as long as you make your payments on time, debtholders cannot control/claim any of your other cash.
They have no *claim*, true, but neither do equity holders. The money *can* be used to pay off debt holders if they choose, and therefore flow to debt. I already memorized it so i could care less, but i just found it an odd representation. This is not the way i see FCFE done in most models.
markCFAIL Wrote: ------------------------------------------------------- > They have no *claim*, true, but neither do equity > holders. The money *can* be used to pay off debt > holders if they choose, and therefore flow to > debt. Can be used to pay off debtholders if who chooses? The majority equity holders of course! This is why net borrowing is part of free cash flow to equity and not debt. Any extra cash beyond required payments to debtholders can only flow to them if equity holders (i.e. ownership) make that choice. Debt holders cannot demand anything beyond what they are due, hence net borrowing does not freely flow to them. CFA (and a huge part of the level II curriculum) would argue very strongly (and correctly in my view) that the FCFE models you are seeing are incorrectly specified.
also, keep in mind that these net borrowed funds are going to be used to finance working capital, new fixed investments, new long term projects, etc. Debt holders have absolutely no say in how/where these borrowed funds are used, this is a shareholder/ownership decision.