The book is not very clear about the effect of changing leverage on FCFF/FCFE. what happens with a change of leverage? The way Im looking at it is if leverage changes, interest changes, thus both the formulas will be affected.
thanks in advance
If leverage changes, a company’s capital structure changes as well. If company’s capital structure changes frequently the FCFE ( which accounts for Borrowings ) growth will not reflect the true fundamental bcz there will be too much of uneven growth due to frequent changes in Capital Structure, therefore FCFE Model will not be a suitable model but instead FCFF model be used in such circumstances. You are correct both FCFF & FCFE are affected by Interest changes but not in the year in which it is borrwed, in fact it is affected in the next year of the borrowing when interest is due. Whereas only FCFE is affected in the year of Borrowing by the borrowed money.