Hey folks,
Wondering if someone can clear this up for me…couldn’t find any answers online or in previous threads.
I’m doing multi-method valuation and had just prepared FCFF for discounting when something started bugging my mind… When calculating the yearly cash movements for a firm why do I use FCFE and not the sum of the cash from operations, cash from investing and cash from financing? FCFE includes debt financing but not equity financing… In other words, why are movements in equity not included in cash flow movements when they do in fact provide liquidity - for example through the issuance of equity?
Hope someone can put this analysts head to rest…
Many thanks,
Choppie
If you’re doing a basic DCF, then you shouldn’t use either of the cash flows you mentioned above. You should be using Unlevered Free Cash Flow (UFCF), which is equal to “EBIT*(1-Tax Rate) + Depreciation and Amortization - Change in Net Working Capital - Capital Expenditures”. When doing valuation, we typically want to start with the value of the entire firm is, which is the Enterprise Value. With UFCF, it is the amount of cash flow available to ALL investors after operations have been funded. As you can see from the formula above, any cash flows from debt or equity are NOT captured in UFCF. If you were to use Levered Free Cash Flow, which you called FCFE, then we would get the Equity Value of the firm, which is cash flow available to equity investors AFTER mandatory debt payments have been met. We would never use the final formula you mentioned (Operating Cash Flow + Investing + Financing) to do valuation because it’s not wholly attributable to the equity investor group.
Hey man. I'm using FCFF for DCF - which is what you refer to as the unlevered CF - as I should... but the question is not DCF-related. I'm just wondering why equity movements aren't considered in ending cash flow balances. Seen it many times in ending cash statements, but never made any sense to me?
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