NPV FCFF vs FCFE

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passa11

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Hello !
stuck with this simple question, getting different answers while using FCFF or FCFE.

•Firm has target capital structure that is 50% debt, 50% equity
•Interest rate on new debt would be 9%
•Required return on equity is 12%
•Tax rate is 35%
•Project will generate FCFF=$50 per year, forever
•Any debt taken on because of the project will be perpetual, principal never paid back
•Initial investment = $500
•
•What is NPV using FCFF and using FCFE?

so wacc = 0.5*0.12 + 0.5*0.09*(1-0.35)= 8.925%
my answer using FCFF is = 50/0.08925-500=60.225

but when using FCFE = 50-250*9%*(1-35%) = 35.375
and NPV is =35.375/0.12 - 250 = 44.79

so could anyone help and point on the mistake
cheers :)
 
passa11: What are you trying to do? You realize that it is OK for FCFE and FCFF values to be different, right? I haven’t run your numbers, but you approach looks fine to me.
 
it has to be same NPV when using FCFF or FCFE.
I have found my mistake it was using inappropriate leverage level.
 
Why would you use FCFE to compute NPV for a project (except as a starting point from which one backs out FCFF)? It seems rather bizzare to me.
I could see using the change in FCFE to figure out how much a project might affect the equity price, but that’s a different number than NPV.
 
Why we can not use FCFE to find project’s NPV ? I think it seems legit to use both (FCFFE and FCFF) of them but we have to get same answers.
it is tricky one and has very few literature about it, now I am stuck with the next task
project has 5 years lifetime
initial investment is 1000
EBIT for 5 years is 250 per year
firm has 200 equity
firm borrowed 800 debt and it will be repaid after 3 years
pretax cost of debt is 10%
t rate is 30%
cost of equity is 15%
find NPV using FCFF and FCFE
pls someone help :)
 
passa11 wrote:
it has to be same NPV when using FCFF or FCFE.
Click to expand...
I hope you don’t plan on carrying this understanding and your “NPV approach” to L2/L3. It’s just erroneous to use FCFE/FCFF for valuing projects. Also, FCFE =/= FCFF.
Unless some criteria are met, FCFF and FCFE valuation will produce different numbers. FCFE is capital available to equity shareholders after higher stakeholders in the firm’s capital structure (debtholders and preferred shareholders) have been compensated.
 
thanks! will try find appropriate literature.
 
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