Question

Discuss the similarities and differences between using FCFF (Free Cash Flow to the Firm) versus using FCFE (Free Cash Flow to Equity). When might one approach be preferred over the other? Be sure to discuss the proper discount rate to use for each approach as well.

Answer 1

The key differences between fcff and fcfe are as follows :-

1. Fcff is used to calculate cash flow available to all investors

FCFE is used to calculate cash flow available to equity stakeholders

2. FCFF is used to calculate enterprise value while FCFE is used to calculate equity value

3. FCFF includes the impact of leverage while FCFE does not

4. FCFF uses discount rate as Wacc while FCFE used required return on equity

Similarities

1. Both are measured of calculating Free cash flow

2. Both are based on the absolute valuation technique

3. Both are used in combination with DCF model

I hope this helps