Free Cash Flow

Summaries

FCFF (FCF for firm) is the cash available to all of the firm’s investors and bond holders, after the firm buys and sells products, pays operating cash expenses and do short term and long term reinvestment.

*** Therefore, the definition of NWC excludes cash and short term liability because cash (and equivalent) is not investment and short term liability and current portion of long term debts is a part of invested capital. (***But include account payble in the equation)

*** Interest is excluded because it is the free cash to pay the bond holders and also it is not operating cash flow

FCFE (FCF for equity) those left for investors.

Firm value = FCFF discounted at WACC

(*** This is just the value of the operating assets. May have to add non-operating assets is need to get the true firm value)

Equity value = FCFE discounted at required return of equity

Equity value = firm value – market value of the debt

FCFF approach to value the firm is from the perspective of the controlling party. For minority shareholders, dividend approach is better BUT FCFF should be used when they are “in-play”, that is the firm is a take over target.

FCFF = NI + interest*(1-t) + non-cash charges (NCC) – change of capital investment – change of NWC

NCC: depreciation, amortization of asset and bonds, restructuring, deferred tax, gain and loss of selling equipment

FCInv: capital expenditures – proceeds from sales of long-term assets

*** Gross PP&E is the one before depreciation. (If not sale of assets, FCInv = change of gross PP&E)

CFO = NI + NCC – WCInv

So FCFF = CFO – FCInv + I(1-t)

*** Interest is CFO, so add I(1-t) as we “treat” as CFF here.

FCFE = FCFF – I(1-t) + net borrowing

Net borrowing = long/short term debt issued – long/short term debt repayment

FCFF = EBIT (1-t) + Dep –FCInv – WCInv

*** EBIT (1-t) = EBIT – adjusted tax = EBIT – (tax + It)

***Since most NCC are below EBIT, therefore, not need to do adjust in this equation.

FCFF = EBITDA (1-t) + Dep *t – FCInv – WCInv

With preferred stock, FCFE should have the net borrowing including the preferred stocks

Dividend, share issues, share repurchase has no effect on FCFE and little effect on FCFF

Single stage model: Value of the firm = FCFF_1/(WACC – g)

*** for WACC, use market values to find the weights

Single stage model: Value of the equity = FCFE_1/(r – g)