DCF- Free Cash Flow to Firm/Equity HELP

Hi guys , just want to make sure a few facts straight here,

1, FCFF(Free Cash Flow to Firm) also called Unlevered FCF, FCFE(free cash flow to Equity) also called Levered FCF?
2, FCFF discounted by WACC ( cost of equity is calculated using unlevered Beta)=Enterprise Value
FCFE discounted by Cost of Equity (calculated using levered beta)=equity value
So, Enterprise Value- Mrkt value of Debt=Equity Value. this relationship should hold theoretically , Correct?
In what circumstances they do not hold?what am i missing if any?

Thanks very much in advance!

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Comments (6)

Feb 16, 2011 - 1:33am

You mean net debt right? if you mean market value of debt, then its not right. because cash on hand can be used to service some of the debt.

Therefore,
Enterprise Value = Net Debt + Equity Market Value + Preferred Stock (acts like debt) + Minority Interest.

Hopefully this helps.

Feb 16, 2011 - 1:45am

1) Yes
2) The beta is levered (The beta does not change whether or not you use unlevered or levered FCF)

Enterprise Value = MVE (Equity Value) + Net Debt + Preferred Stock + Minority Interest - Cash

Someone correct me if I'm wrong on statement #2.

-- "Those who say don't know, and those who know don't say."
Feb 16, 2011 - 9:48am

EV = market value of equity (common & preferred) + (market value of debt - cash) [also known as net debt]

FCFF discounted at WACC does NOT use unlevered beta, the cash flows are unlevered (i.e. calculated starting at EBIT(1-T) rather than NI), but the beta used in the discount rate is not. The appropriate WACC will use the company's target leverage going forward.

However,

If you were to use an APV method, the discount rate would use the unlevered beta. The unlevered cash flows would then be discounted at this rate, while the tax savings associated with leverage each year would be discounted at Rd.

This will yield a slightly different (but theoretically more accurate) valuation than WACC.

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