calculation of FCFE using FCFF

S

Sanjay Sachdev

New member
Joined
Nov 27, 2014
Messages
0
Reaction score
0
Hey Guys,

I am bit confused while remembering the FCFE formula, In general, if the company has debt and preferred shares the FCFE can be calculated by simply subtracting the Market Value of Debt and M.v of preferred shares from FCFF…my doubt here is that why we are not considering Interest expense and preferred dividends in the below formula, as these two items reduces cash to shareholders…

FCFE = FCFF - M.V debt - M.V Preferred shares ( why should the dividends and interest on debt are not being considered here ?)
 
your starting point in your formula is FCFF
and FCFF -> in the indirect method - starts from Net Income.
To arrive at Net Income - you have removed both the effect of dividends and the interest paid on Debt already.
if you included it again, you would now end up double counting.
 
You actually would subtract the interest expense (adjusted for taxes) and preferred dividends, and would also add back the net borrowing (additional debt) to get from FCFF to FCFE. You would then use FCFE to get to equity value directly (usually using a DCF with the cost of equity as the discount rate)
If you used FCFF you would first reach the value of the firm, and once you have the value for the firm (using the WACC) you would subtract the value of debt and preferred shares to reach the value of equity.
 
FCFF = NI + DEP + INT (1-t) - FCI - WCI now, to calc FCFE from FCFF we should subtract these two components right ? Plz correct me if I’m wrong here…in one of the material FCFE is calc as FCFE= FCFF - MV of Debt - MV of Preferred shs (why dividends and int are not deducted here ?)
 
I would check that material again, comparing free cash flow and the value of debt or preferred shares is comparing apples to oranges, one is over a time period (example: the projected free cash flow in 2015) vs a single point in time (example: the market value of debt on 11/29/2014). You would not deduct or add the market value of anyhting to get either free cash flow, you only use income statement and cash flow statement items (examples: net income, change in working capital, interest expense).
FCFE=FCFF - INT(1-t) + Net borrowing (additional debt borrowed-debt repaid) - preferred dividends + (additional preferred stock sold - preferred stock purchased). Again, this is for a period of time (usually a year).
Often there is no preferred stock, in that case you would only worry about the debt and interest.
 
Thanks Ron :) To keep you posted, I’ve found this sum in Schweser Topic : EQ (2014 edition) pg 173 Q 6 to 9
 
You must log in or register to reply here.
Back
Top