Question

Explain how the company's definition and calculation compares to the comprehensive FCFF and FCFE. Also, explain how the third party's definition and calculation compares to the comprehensive FCFF and FCFE.

Answer 1

Free Cash Flow to Firm (FCFF),also known as Unlevered Free Cash Flow) and Free Cash Flow to Equity (FCFE), commonly known to as Levered Free Cash Flow

(A) FCFE

Free cash flow to equity is a measures, how much cash is available to the equity shareholders of a company or firm after all expenses, reinvestment, and debt are paid.

Formula

FCFE = Cash from operations - Capital expenditure + Net debt issued

Calculation of  FCFE

Free cash flow to equity is combination  of net income, capital expenditures, working capital, and debt.Capital expenditures can be found within the cash flows from investing section in the cash flow statement. Net income can be located on the company income statement. Working capital is also loacted on the cash flow statement; however, it is in the cash flows from the operations section. so, working capital represents the difference between the company’s most current assets and liabilities.These are short-term capital requirements related to immediate operations. Net borrowings can also be found on the cash flow statement in the cash flows from financing section.

NOTE; Interest expense is already included in net income so you don't add back interest expense.

(B) FCFF

• Free cash flow to the firm indicates the cash flows from operations available for distribution after depreciation expenses, taxes, working capital, and investments are accounted for. Free cash flow is the most important financial indicator of a company's stock value.
• A positive Free cash flow value indicates that the firm has cash remaining after expenses. A negative value represents that the firm has not generated enough revenue to cover its costs and investment activities.

Formula

FCFF = Net income + Net non cash charges + (interest *( 1 - Tax rate)) - long term investments - investment in long term working capital

Calculation of FCFF

FCFF calculation is a good representation of a company's performance and its operations. FCFF consider all cash inflows in the form of revenues, all cash outflows in the form of ordinary expenses, and all reinvested cash to grow or develop the business.The money left after conducting all these operations represents a company's FCFF. FCFF helps the investors to test whether a stock is fairly valued. FCFF also indicates a company's ability to pay dividends, conduct share repurchases, or pay back debt holders. Each and every investors looking to invest in a company's corporate bond or public equity should check its FCFF.

A positive FCFF value indicates that the firm has cash remaining after expenses. A negative value indicates that the firm has not generated enough revenue to cover its costs and investment activities. this time an investor should look to assess why this is happening. It can be a result of a specific business purpose, as in high-growth tech companies that take consistent outside investments, or it could be a indicator of financial issues.