Hi Friends! We ate WWW.assignmentconsulatncy
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help. Let’s begin today’s journey with a basic question i.e. what is
difference between FCFF and FCFE in terms of cash flow? FCFF is actually
the cash available to bond holders and stock holders after all expense and
investments have taken place whereas FCFE is the cash available to stock
holders after all expense, investments and interest payments to debtholders on
an after tax basis.
Hence the basic difference lies because of consideration of
interest payment in FCFE i.e. in FCFE you subtract the interest expense from
the cash flow to do valuations. Hence, FCFF shows the obligations for both
stockholders as well as bondholders whereas FCFE consider only the obligations
for stockholders. Apart from the difference mentioned above and in my last post
about FCFF and FCFE, there lies some more difference which is basically related
to approach that we will use while doing valuation.( Will discuss in details in
my later post)
Now, the question is how do we calculate the FCFF and FCFE? FCFF
can be calculated by using the formulae as mentioned below:
FCFF =
EBIT (1 t) + Depreciation + Amortization – Change in Non Cash Working Capital
– Capital Expenditure
Where,
EBIT = Earnings before income tax
t = Corporate tax rates
Whereas FCFE can be calculated by using formula mentioned below,
FCFE = Net
Income + Depreciation + Amortization – Change in Non Cash Working Capital
*(1D) – Capital Expenditure*(1D)
Where,
D = Debt ratio
Now, there lies two important points about these formulas, those
are as follows:
1) In FCFF, we use EBIT (1t)
whereas in FCFE, we use Net Income; this is because while using EBIT (1t) in FCFF
we do not consider the effect of interest payment as mentioned above.
2) IN FCFE, we use Change in Non
Cash Working Capital*(1D) – Capital expenditure*(1D) whereas in FCFF we use
Change in NonCash Working Capital – Capital Expenditure; this is because
we just want to concentrate on cash flow due to equity only.
The calculation of FCFF or FCFE is the first step to do
valuations. Now, the important question is what are the important factors that
we must consider while calculating EV through FCFF and FCFE methods? The
different factors that one must consider are as follows:
Factors

FCFF

FCFE

Cash Flows

Pre Debt Cash Flows (already
mentioned above)

post Debt Cash Flows (already
mentioned above)

Expected Growth

Growth in Operating Income =
Reinvestment rate * ROC

Growth in Net Income
= Retention ratio * ROE

Discount Rate

WACC

Cost of Equity

Beta

Bottom up

Bottomup

These factors are of no use until you know about the assumptions
you must take while calculating EV through FCFF and FCFE methods. Hence, the
art of valuations lie in your understanding about these factors and its uses
which I will explain later.
Hope this post helps you in understanding the difference between
FCFF and FCFE from cash flows perspectives. I
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