What Is Free Cash Flow to Equity (FCFE)?
Free cash flow to equity is a measure of how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid. FCFE is a measure of equity capital usage.
Understanding Free Cash Flow to Equity
Free cash flow to equity is composed of net income, capital expenditures, working capital, and debt. Net income is located on the company income statement. Capital expenditures can be found within the cash flows from the investing section on the cash flow statement.
Working capital is also found on the cash flow statement; however, it is in the cash flows from the operations section. In general, working capital represents the difference between the company’s most current assets and liabilities.
Key Takeaways
- A measure of equity cash usage, free cash flow to equity calculates how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid.
- Free cash flow to equity is composed of net income, capital expenditures, working capital, and debt.
- The FCFE metric is often used by analysts in an attempt to determine the value of a company.
- FCFE, as a method of valuation, gained popularity as an alternative to the dividend discount model (DDM), especially for cases in which a company does not pay a dividend.
These are short-term capital requirements related to immediate operations. Net borrowings can also be found on the cash flow statement in the cash flows from financing section. It is important to remember that interest expense is already included in net income so you do not need to add back interest expense.
The Formula for FCFE
FCFE=Cashfromoperations−Capex+Netdebtissued
What Does FCFE Tell You?
The FCFE metric is often used by analysts in an attempt to determine the value of a company. This method of valuation gained popularity as an alternative to the dividend discount model (DDM), especially if a company does not pay a dividend. Although FCFE may calculate the amount available to shareholders, it does not necessarily equate to the amount paid out to shareholders.
Analysts use FCFE to determine if dividend payments and stock repurchases are paid for with free cash flow to equity or some other form of financing. Investors want to see a dividend payment and share repurchase that is fully paid by FCFE.
If FCFE is less than the dividend payment and the cost to buy back shares, the company is funding with either debt or existing capital or issuing new securities. Existing capital includes retained earnings made in previous periods.
This is not what investors want to see in a current or prospective investment, even if interest rates are low. Some analysts argue that borrowing to pay for share repurchases when shares are trading at a discount, and rates are historically low is a good investment. However, this is only the case if the company's share price goes up in the future.
If the company's dividend payment funds are significantly less than the FCFE, then the firm is using the excess to increase its cash level or to invest in marketable securities. Finally, if the funds spent to buy back shares or pay dividends is approximately equal to the FCFE, then the firm is paying it all to its investors.
Example of How to Use FCFE
Using the Gordon Growth Model, the FCFE is used to calculate the value of equity using this formula:
Vequity=(r−g)FCFE
Where:
- Vequity= value of the stock today
- FCFE = expected FCFE for next year
- r =cost of equityof the firm
- g = growth rate in FCFE for the firm
This model is used to find the value of the equity claim of a company and is only appropriate to use if capital expenditure is not significantly greater than depreciation and if the beta of the company's stock is close to 1 or below 1.
FAQs
How do you calculate cash flow to equity? Free cash flow to equity can be calculated in multiple ways, using EBIT or net income. When using net income, the formula is FCFE= Net income + Depreciation - Capital Expenditures - Change in Working Capital + Net Borrowing.
What is the formula for free cash flow to equity FCFE? ›
FCFE is calculated as Net Income + Depreciation and Amortization (D&A) – Change in Net Working Capital – Capital Expenditures (Capex) + Net Borrowing. FCFE represents the cash flow available to equity investors, and is thereby a levered metric, since non-equity claims were met.
How do you calculate free cash flow examples? ›
To calculate FCF, locate sales or revenue on the income statement, subtract the sum of taxes and all operating costs (listed as “operating expenses”), which include items such as cost of goods sold (COGS) and selling, general, and administrative costs (SG&A).
What is the difference between free cash flow to the equity FCFE and free cash flow to the firm FCFF )? ›
The FCFF method utilizes the weighted average cost of capital (WACC), whereas the FCFE method utilizes the cost of equity only. The second difference is the treatment of debt. The FCFF method subtracts debt at the very end to arrive at the intrinsic value of equity.
How is FCFE used in DCF? ›
FCFE is a crucial metric in one of the methods in the Discounted Cash Flow (DCF) valuation model. Using the FCFE, an analyst can determine the Net Present Value (NPV) of a company's equity, which can be subsequently used to calculate the theoretical share price of the company.
When to use FCFE? ›
This model is used to find the value of the equity claim of a company and is only appropriate to use if capital expenditure is not significantly greater than depreciation and if the beta of the company's stock is close to 1 or below 1.
What is the two stage FCFE model? ›
The two stage FCFE model is designed to value a firm which is expected to grow much faster than a stable firm in the initial period and at a stable rate after that.
What is free cash flow for dummies? ›
You figure free cash flow by subtracting money spent for capital expenditures, which is money to purchase or improve assets, and money paid out in dividends from net cash provided by operating activities.
What is the formula for free cash flow present value? ›
The FCFF valuation approach estimates the value of the firm as the present value of future FCFF discounted at the weighted average cost of capital: Firmvalue=∞∑t=1FCFFt(1+WACC)t. Firm value = ∑ t = 1 ∞ FCFF t ( 1 + WACC ) t .
How to calculate free cash flow in Excel? ›
Enter "Total Cash Flow From Operating Activities" into cell A3, "Capital Expenditures" into cell A4, and "Free Cash Flow" into cell A5. Then, enter "=80670000000" into cell B3 and "=7310000000" into cell B4. To calculate FCF, enter the formula "=B3-B4" into cell B5. There you go.
Net borrowing can be calculated by subtracting the amount of debt repaid in the year from the total debt borrowed during the year.
How do you calculate equity value? ›
Often used interchangeably with the term “market capitalization,” the equity value is calculated by multiplying the current stock price of a company by its total number of fully diluted common shares outstanding trading in the open markets.
Is free cash flow to equity the same as levered free cash flow? ›
The one that generates the most questions and confusion is a Levered DCF based on Levered Free Cash Flow, also known as Free Cash Flow to Equity (FCFE). The basic difference is that Levered Free Cash Flow represents the cash flow available only to the common shareholders in the company rather than all the investors.
How do you calculate free cash flow for DCF valuation? ›
To calculate the Free Cash Flow (FCF) of the company for each year of the forecast period, you must use the formula: Revenue - COGS - OPEX - Taxes + D&A - CAPEX - Change in WC. Additionally, you should calculate the tax rate and effective tax rate of the company using historical data or statutory rates.
How to calculate cost of equity? ›
The CAPM formula can be used to calculate the cost of equity, where the formula used is: Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return - Risk-Free Rate of Return).
What is the formula for calculating free cash flow? ›
The generic Free Cash Flow (FCF) Formula is equal to Cash from Operations minus Capital Expenditures. FCF represents the amount of cash generated by a business, after accounting for reinvestment in non-current capital assets by the company.
How do you calculate free cash flow conversion? ›
Free Cash Flow Conversion Formula (FCF)
The formula for calculating the free cash flow conversion (FCF) rate is as follows. Where: Free Cash Flow (FCF) = Cash from Operations (CFO) – Capital Expenditures (Capex) EBITDA = Operating Income (EBIT) + D&A.
What is the price to free cash flow to equity? ›
Price to free cash flow (P/FCF) is an equity valuation metric that compares a company's per-share market price to its free cash flow (FCF).
