Lets Understand When FCFF and FCFE Based ...

Lets Understand When FCFF and FCFE Based DCF Result In The Same Valuation?

Aug 05, 2023

πŸ’‘ FCFF (Free Cash Flow to Firm) and FCFE (Free Cash Flow to Equity) based DCF models may or may not result in the same valuation.

πŸ’° FCFF represents cash flows available to all capital providers (debt and equity holders), while FCFE represents cash flows available to equity holders only.

πŸ“Š Differences arise due to the treatment of debt and interest payments:

  • FCFF includes interest payments as a cash flow.

  • FCFE deducts interest payments as they are considered cash flows to debt holders.

  • βš–οΈ The choice between FCFF and FCFE depends on the context and purpose of the valuation:

FCFF is suitable for valuing the entire firm.

FCFE is more appropriate for valuing equity specifically.

πŸ”„ Valuation results can differ due to:

  • Assumptions about reinvestment needs and debt obligations.

  • Treatment of interest payments.

  • Discounting at different rates (WACC vs. cost of equity).

  • Focus on enterprise value (FCFF) or equity value (FCFE).

βœ… Valuations may converge when there is minimal debt or a stable capital structure.

πŸ” Analysts should consider the company's capital structure and valuation objectives when choosing between FCFF and FCFE.

πŸ’Ό FCFF-based DCF provides enterprise value, while FCFE-based DCF provides equity value.

⚠️ It's important to note that FCFF is a comprehensive measure, while FCFE is more focused on equity valuation.

πŸ”€ Variations in assumptions, inputs, and estimation techniques can lead to different valuation results.

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