This FCFE calculator is designed to help you easily calculate the free cash flow to equity (FCFE). FCFE is widely used to value a company's equity using the discounted cash flow valuation model.
By reading this article, you will understand what is FCFE and how to calculate it using the free cash flow to equity formula. We will also help you understand the FCFE valuation model. However, before we dive into more complex topics, let's talk about the definition of FCFE.
What is FCFE?
Free cash flow to equity (FCFE) is the cash flow available for distribution to all the company's equity holders after paying all the expenses, reinvestments, and debts. Specifically, one can understand FCFE as the cash flow available to common shareholders after meeting the company's expenses, working capital needs, and debt financing requirements.
Unlike FCFF (Free Cash Flow to the Firm), which is used to perform the valuation for the whole company, the FCFE valuation model focuses only on valuing the company's equity value. This makes FCFE one of the best metrics to use in valuing a company's share price.
Now, let's learn how to use the FCFE formula in the next paragraph.
How to calculate FCFE? The free cash flow to equity formula
Let's use Company Alpha as an example to help us understand the FCFE's concept. Company Alpha reports the following information:
- Net income: $56,000,000;
- Earnings before interest, taxes, depreciation, and amortisation (EBITDA): $145,000,000;
- Earnings before interest and taxes (EBIT): $95,000,000;
- Cash flow from operation (CFO): $81,000,000;
- Depreciation and amortization (D&A): $50,000,000;
- Interest expenses: $15,000,000;
- Corporate tax rate: 30%;
- Fixed capital investment: $100,000,000;
- Working capital investment: $25,000,000;
- Beginning total debt: $110,000,000; and
- Ending total debt: $134,000,000.
There are a couple of ways to calculate FCFE. In this article, we will introduce five FCFE formulae to help you calculate it. But, before this, we will need to calculate the net borrowing as it is needed regardless of what method you use to calculate FCFE.
We can calculate net borrowing
NB using the following formula:
NB = ending total debt - beginning total debt
Hence, Company Alpha's
$134,000,000 - $110,000,000 = $24,000,000.
- Calculate FCFE from net income
FCFEcan be calculated using the formula as follow:
FCFE = NI + D&A - FCI - NWC + NB,
NI- Net income;
D&A- Deprecation and amortization;
FCI- Fixed capital investment; and
NWC- Working capital investment.
For our example,
FCFEfor Company Alpha is:
$56,000,000 + $50,000,000 - $100,000,000 - $25,000,000 + $24,000,000 = $5,000,000.
- Calculate FCFE from EBIT
FCFEcan also be calculated from
EBIT, which stands earnings before interest and taxes, using the
FCFEformula displayed below:
FCFE = EBIT * (1 - CIT) + D&A - FCI - NWC - IE * (1 - CIT) + NB,
IE- Interest expense; and
CIT- Corporate tax rate.
Thus, Company Alpha's
$95,000,000 * (1 - 30%) + $50,000,000 - $100,000,000 - $25,000,000 - $15,000,000 * (1 - 30%) + $24,000,000 = $5,000,000.
- Calculate FCFE from EBITDA
Moreover, earnings before interest, taxes, depreciation, and amortization, or
EBITDAfor short, is also one of the
FCFEcomponents. Their relationship is displayed in the formula below:
FCFE = EBITDA * (1 - CIT) + D&A * CIT - FCI - NWC - IE * (1 - CIT) + NB,
For Company Alpha, its
$145,000,000 * (1 - 30%) + $50,000,000 * 30% - $100,000,000 - $25,000,000 - $15,000,000 * (1 - 30%) + $24,000,000 = $5,000,000.
- Calculate FCFE from CFO
We can also calculate
CFO, which is the cash flow from operation. The formula of this calculation is displayed below:
FCFE = CFO - FCI + NB,
CFO- Cash flow from an operation.
For our example, Company Alpha's
$81,000,000 - $100,000,000 + $24,000,000 = $5,000,000.
- Calculate FCFE from FCFF
Lastly, we can also obtain
FCFF, which stands from free cash flow to firm. We can achieve this by using the formula that follows:
FCFE = FCFF - IE * (1 - CIT) + NB,
Thus, Company Alpha's
FCFEcan be calculated as:
-$8,500,000 - $15,000,000 * (1 - 30%) + $24,000,000 = $5,000,000.
Why use FCFE in company valuation?
One of the most significant advantages of using FCFE to perform a company valuation is that it values the company's equity directly. This is useful if you invest in the company as a common shareholder since you are only concerned with its equity value or share price. If we were to use FCFF instead, we would need to deduct the market value of debt from the results to obtain the equity value or share price. This process can be complicated as the market value of debt can be difficult to determine.
However, if the company being valued does not have a stable capital structure, it might be better to use FCFF instead. Also, if the company has a huge debt to service, resulting in a negative FCFE, it will be difficult to value it using the FCFE. In this case, FCFF is preferred.
Can FCFE be negative?
FCFE can be negative and most early-stage companies have a negative FCFE. A negative FCFE means the company's operation is costing its investors money instead of generating it.
What is the relationship between FCFE and FCFF?
FCFF stands for free cash flow to the firm. While FCFE is the cash available to distribute to the shareholders, FCFF represents the cash available for both debt and equity investors. Putting the relationship as an equation:
FCFE = FCFF - IE × (1 - CIT) + NB.
What is EBIT?
EBIT stands for earnings before interests and taxes. In short:
EBIT = net income + interest expenses + taxes.
EBIT can be interpreted as the operating income of a company.
What is EBITDA?
EBITDA stands for earnings before taxes, interest, depreciation, and amortization. Mathematically:
EBITDA = net income + deprecation and amortization + interest expenses + taxes.
EBITDA is usually understood as the gross profit.