What is the difference between FCFF and FCFE, and when would you use each one?

Free cash flow to the firm (FCFF) represents cash available to ALL capital providers -- both debt holders and equity holders. Free cash flow to equity (FCFE) represents cash available only to equity holders after satisfying debt obligations.

FCFF (Cash to Everyone)

FCFF = Net Income + Non-Cash Charges + Interest Expense x (1 - Tax Rate) - Fixed Capital Investment - Working Capital Investment

Or starting from EBIT:

FCFF = EBIT x (1 - Tax Rate) + Depreciation - CapEx - Change in Working Capital

FCFE (Cash to Equity Only)

FCFE = FCFF - Interest Expense x (1 - Tax Rate) + Net Borrowing

Or more directly:

FCFE = Net Income + Non-Cash Charges - CapEx - Change in Working Capital + Net Borrowing

Relationship:

FCFE = FCFF - Interest x (1 - t) + Net Borrowing - Debt Repayment

Example: Copperton Industries reports:

FCFF:

= $800,000 + $200,000 + $150,000 x (1 - 0.25) - $350,000 - $75,000

= $800,000 + $200,000 + $112,500 - $350,000 - $75,000

= $687,500

FCFE:

= $800,000 + $200,000 - $350,000 - $75,000 + ($100,000 - $50,000)

= $625,000

Verification: FCFE = FCFF - Interest x (1-t) + Net borrowing

= $687,500 - $112,500 + $50,000 = $625,000 (matches)

When to Use Each

• Use FCFF when the company's capital structure is changing significantly or when leverage is very high. Discount at WACC.
• Use FCFE when the capital structure is stable and you want to value equity directly. Discount at the cost of equity.
• FCFF is generally preferred for cross-company comparisons because it is capital-structure neutral.

Exam Tip: The CFA exam frequently asks you to compute one from the other. The bridge between them is after-tax interest expense and net borrowing. Memorize both formulas and practice the reconciliation.

Explore our CFA Level I course for more valuation cash flow examples.