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Free Cash Flow to Equity (FCFE)

Guide to Understanding Free Cash Flow to Equity (FCFE)

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Free Cash Flow to Equity (FCFE)

In This Article
  • What is the formula used to calculate the free cash flow to equity (FCFE)?
  • How does levered free cash flow (FCFE) differ from unlevered free cash flow (FCFF)?
  • For forecasting purposes, what is the right discount rate to use for FCFEs?
  • If starting from EBITDA, rather than net income or cash flow from operations, how do you calculate FCFE?

How to Calculate FCFE

In our previous post, we discussed the meaning and calculation of free cash flow to firm (FCFF), which is often referred to as “unlevered” free cash flow.

The reason for this is that the effects of debt financing have been removed – namely, interest expense, the “tax shield” (i.e., savings from interest being tax-deductible), and principal debt repayments.

Since FCFE is a “levered” metric, the value of the cash flows must include the impact of financing obligations.

So, rather than representing the cash available to all capital providers, FCFE is the amount remaining for just equity investors.

For instance, the company could use the residual cash to fund:

  1. Dividend Issuances: Payout cash dividends directly to preferred and common shareholders
  2. Share Repurchases: Buying back shares reduces the shares outstanding, which reduces dilution and can artificially boost the value per share
  3. Re-Investments: The company could reinvest the cash into its operations, which in the ideal scenario would increase the share price

The clear pattern is that these actions benefit the equity holders.

Contrast this to interest expense or debt repayments, which solely benefit lenders. That said, the FCFE could be equivalent to the FCFF if there is zero debt in the capital structure.

FCFEs can be projected in a levered discounted cash flow model (DCF) to derive to the market value of equity. Furthermore, the correct discount rate to use would be the cost of equity, as the cash flows and discount rate must match up in terms of the represented stakeholders.

However, in practice, the FCFF approach and unlevered DCF are used across most industries. The one notable exception is financial institutions, since their main source of revenue is interest income – making it unfeasible to separate the unlevered FCF since the business model itself is oriented around financing (e.g., interest income, interest expense, provision for losses).

FCFE Formula [Net Income → FCFE]

The calculation of FCFF begins with NOPAT, which is a capital-structure neutral metric.

For FCFE, however, we begin with net income, a metric that has already accounted for the interest expense and tax savings from any debt outstanding.

FCFE Formula
  • FCFE = Net Income + D&A – Change in NWC – CapEx + Net Borrowing

Since FCFE is intended to reflect the cash flows that go only to equity holders, there is no need to add back the interest, interest tax shield, or debt repayments. Instead, we simply add back non-cash items, adjust for the change in NWC, and subtract the CapEx amount.

However, another key distinction is the deduction of the net borrowing, which is equal to the debt borrowed net of the repayment.

Net Borrowing Formula
  • Net Borrowing = Debt Borrowing – Debt Paydown

The reason we include the debt borrowed, as opposed to just the debt paydown, is that the proceeds from the borrowing could be used to distribute dividends or repurchase shares.

Mandatory vs. Optional Debt Repayments

As a side note, typically only the mandatory scheduled debt repayments are included in the calculation of net borrowing.

For example, a cash sweep in an LBO model (i.e., optional repayment of debt) would be excluded because the management could have chosen to use those proceeds instead for other purposes that pertain to equity shareholders.

In comparison, scheduled repayments to lenders are non-discretionary; if they are not paid, the company will default on the debt.

FCFE Formula [CFO → FCFE]

In the next approach, the formula for FCFE starts with cash flow from operations (CFO).

FCFE Formula
  • FCFE = CFO – CapEx + Net Borrowing

Recall, CFO is calculated by taking net income from the income statement, adding back non-cash charges, and adjusting for the change in NWC, so the remaining steps are to just account for CapEx and the net borrowing.

FCFE Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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FCFE Example Calculation

Suppose a company’s net income is $10mm given a 10% net income margin assumption and $100mm in revenue.

Next, the D&A of $5mm is added back since it is a non-cash expense, and then we subtract the $3mm in CapEx and $2mm increase in NWC.

That leaves us with $10mm, but then we must subtract the $5mm in debt paydown, which leaves us with $5mm as the FCFE.

FCFE Excel

In the 2nd example, we begin with a CFO of $13mm ($10mm in net income + $5mm in D&A – $2mm in Change in NWC).

Then, we subtract the $3mm in CapEx and $5mm in debt paydown to get $5mm once again.


Unlike net income and CFO, EBITDA is capital-structure neutral.

Therefore, if we start with EBITDA, we must deduct the impact of debt financing to remove the cash that belongs to lenders.

FCFE Formula
  • FCFE = EBITDA – Interest – Taxes – Change in NWC – CapEx + Net Borrowing

Within the EBITDA metric, the only debt-related component is the interest, which we subtract. Notice that we just are working down the income statement to net income (or the “bottom line”).

That said, the subsequent step is to account for taxes, and there is no need to make additional adjustments to the tax amount as we want to include the interest tax shield.

Now that we have gone from EBITDA to net income, the same steps apply, where we deduct the change in NWC and CapEx. In the final step, we subtract the net borrowing for the period to arrive at the FCFE.

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June 26, 2022 5:10 am

If you’re doing a DCF valuation, do you still need to add cash on hand and minus total debt in the base year when deriving the equity value?

February 7, 2022 4:40 pm

Hi, great post!
One questio i got reading the post. If the change in working capital is negative lets say -10, it will be added to te FCFE formula right? -(-10)

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