How to Calculate FCFE from EBITDA
FCFE is Free Cash Flow to Equity. And EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization.
How To Calculate FCFE From EBITDA?
FCFE is free cash flow to equity. FCFE is free cash available to the firm’s equity shareholders after meeting all expenses and paying off debt obligations.
FCFE can also be calculated from net income or cash flow from operations (CFO).
EBITDA stands for earnings before interest, tax, depreciation, and amortization. EBITDA can be derived using the following formula:
EBITDA = Net income + Interests + Taxes + Depreciation + Amortization
Net income is earnings/profit the company earns. It is determined after subtracting taxes from earnings before tax.
Interest is an obligation associated with debt. Interest can be calculated on the level of debt and the interest rate.
Tax is an obligation of the company and applies to the amount of the company’s profits. The higher the yield, the more the taxes. Taxes can be calculated based on corporate earnings and tax rates.
Depreciation and amortization are noncash expenses. Tangible assets decrease in value as used over time in the form of depreciation expense, whereas intangible assets are amortized as time passes.
FCFE can be calculated starting from EBITDA as follows:
FCFE = EBITDA - Interests - Taxes - Change in working capital - Capital expenditures + Net borrowing
Change in working capital is also called operating capital. Working capital is based on current assets and current liabilities.
Accounts receivable, inventory, and cash are examples of current assets. Current liabilities are accounts payable and notes payable.
Change in working capital is ending working capital minus beginning working capital. Working capital is determined by subtracting current assets and current liabilities.
Change in working capital = Ending working capital - Beginning working capital
Beginning working capital = Beginning current assets - Beginning current liabilities
Ending working capital = Ending current assets - Ending current liabilities
Capital expenditures are expenses associated with the buying and maintenance of fixed assets such as land, buildings, and PPE. Capital expenditures are also called FCInv. FCInv is a fixed capital investment.
Net borrowing is based on debt outstanding and debt repaid.
Net borrowing = Debt outstanding - Debt repaid
Key Takeaways
- FCFE is free cash available to the firm’s equity shareholders.
- FCFE can be calculated starting from EBITDA.
- EBITDA is earnings before interest, tax, depreciation, and amortization.
- FCFE from EBITDA components is EBITDA, Interests, Taxes, Change in working capital, Net borrowing, and Capital expenditures.
- Change in working capital is based on ending working capital and beginning working capital. Working capital is operating capital calculated as current assets minus current liabilities.
- Capital expenditure is expenditure related to the purchasing of fixed assets.
- Net borrowing is derived by subtracting debt repaid from debt outstanding.
Examples Of How To Calculate FCFE From EBITDA
Let’s go through multiple ways in which FCFE can be derived from EBITDA.
Example 1:
| Particulars | Amount |
|---|---|
| Net income | $120,000 |
| Interests | $4,500 |
| Taxes | $2,000 |
| Depreciation and amortization | $5,000 |
| Change in working capital | $90,000 |
| Capital expenditures | $50,000 |
| Net borrowing | $75,000 |
From here, we need to calculate the following:
- EBITDA
- FCFE from EBITDA
Now, to calculate EBITDA, we’ll use the following formula:
EBITDA = Net income + Interests + Taxes + Depreciation and amortization
= $120,000 + $4,500 + $2,000 + $5,000 = $131,500
Next, to calculate FCFE from EBITDA, we’ll use:
FCFE from EBITDA = EBITDA - Interests - Taxes - Change in working capital - Capital expenditures + Net borrowing
= $131,500 - $4,500 - $2,000 - $90,000 - $50,000 + $75,000 = $60,000
Let us go through example 2.
| Particulars | Amount |
|---|---|
| EBITDA | $130,000 |
| Beginning working capital | $10,000 |
| Ending working capital | $50,000 |
| Capital expenditure | $45,500 |
| Net borrowing | $74,960 |
| Interests | $5,100 |
| Taxes | $1,050 |
We need to calculate:
- Change in working capital
- FCFE from EBITDA
For Working Capital:
Change in working capital = Ending working capital - Beginning working capital
= $50,000 - $10,000 = $40,000
Next, for FCFE from EBITDA:
FCFE from EBITDA = EBITDA - Interests - Taxes - Change in working capital - Capital expenditures + Net borrowing
= $130,000 - $5,100 - $1,050 - $40,000 - $45,500 + $74,960 = $113,310
Let us take a look at example 3:
| Particulars | Amount |
|---|---|
| EBITDA | $1,000,000 |
| Interests | $7,500 |
| Taxes | $5,000 |
| Change in working capital | $100,000 |
| Capital expenditures | $45,700 |
| Debt outstanding | $50,690 |
| Debt repaid | $12,230 |
Let’s calculate:
- Net borrowing
- FCFE from EBITDA
For Net Borrowing, we’ll use
Net borrowing = Debt outstanding - Debt repaid
= $50,690 - $12,230
= $38,460
Next, we’ll calculate FCFE from EBITDA.
FCFE from EBITDA = EBITDA - Interests - Taxes - Change in working capital - Capital expenditures + Net borrowing
= $1,000,000 - $7,500 - $5,000 - $100,000 - $45,700 + $38,460
= $880,260
Let us take a look at Example 4:
| Particulars | Amount |
|---|---|
| EBITDA | $120,000 |
| Interests | $8,550 |
| Taxes | $3,800 |
| Change in working capital | $20,000 |
| Capital expenditures | $100,000 |
| Net borrowing | $10,000 |
Again, we need to calculate FCFE from EBITDA
Therefore, we’ll use:
FCFE from EBITDA = EBITDA - Interests - Taxes - Change in working capital - Capital expenditures + Net borrowing
= $120,000 - $8,550 - $3,800 - $20,000 - $100,000 + $10,000
= -$2,350
Formula Variables Impact On FCFE
A positive/increase in EBITDA will lead to increased/positive FCFE. The correlation between EBITDA and FCFE is positive. The higher the EBITDA, the more cash available to the firm’s equity shareholders.
The following factors will increase EBITDA and ultimately lead to an increase in FCFE:
- An increase in net income
- An increase in depreciation and amortization
Change in working capital is negatively correlated to FCFE. The less the change in working capital, the greater the free cash will be available to the firm’s equity shareholders.
If the change in working capital is positive, then that indicates the ending working capital is less than the beginning working capital, which would lead to a decrease in FCFE.
A positive change in working capital (more change) will negatively impact FCFE. An unfavorable change in working capital (less change) will positively impact FCFE as FCFE will increase.
An increase in capital expenditures or a positive capital expenditure number will lead to a decrease in FCFE. If more fixed assets are purchased, capital expenditures will increase, resulting in less cash available to the firm’s equity shareholders, who have the last residual income claim.
A decrease in capital expenditures or a negative capital expenditure number will have the opposite effect and positively impact FCFE. The lower the capital expenditures, the higher the FCFE.
An increase in net borrowing means more debt is outstanding than is repaid. An increase or a positive net borrowing will positively impact FCFE. Increasing net borrowing will also increase FCFE.
A decrease in net borrowing means more debt is repaid than is outstanding. For repaying debt, more free cash will be used, leading to less free cash available to the firm’s equity shareholders. Decreasing net borrowing will also decrease FCFE.
FCFE And EBITDA Related Ratios
FCFE and EBITDA are both cash flows. Both FCFE and EBITDA can be used in valuation ratios as follows:
Let us take Example 1 to understand the concept better:
Price/FCFE ratio = Price per share/FCFE per share
FCFE per share = FCFE/Number of shares outstanding
| Particulars | Amount |
|---|---|
| Price Per Share
|
$25 |
| FCFE | $105,000 |
| Number of shares outstanding | 10,000 |
Calculate:
- FCFE per share
- Price/FCFE ratio
To calculate FCFE per share, we’ll use the below formula:
FCFE per share = FCFE/Number of shares outstanding
=$105,000/10,000
=$10.50
To calculate the Price/FCFE ratio, we’ll use the below formula:
Price/FCFE ratio = Price per share/FCFE per share
= $25/$10.50
=2.38
Let’s take a look at another example:
To calculate the Price/ EBITDA ratio, we’ll use the below formula:
Price/EBITDA ratio = Price per share/EBITDA per share
| Particulars | Amount |
|---|---|
| Price per share | $45.50 |
| EBITDA per share | $30.50 |
Calculate
To calculate the Price/EBITDA ratio, we’ll use the below formula:
Price/EBITDA ratio = Price per share/EBITDA per share
= $45.50/$30.50
= $1.49
Next, we need to calculate different values, such as
Value of equity = (FCFE * (1 + Constant growth rate))/ (Cost of equity - Constant growth rate)
Cost of equity = Risk-free rate + Beta * (Market return - Risk-free rate)
Value of firm = Value of equity + Market value of debt
| Particulars | Amount |
|---|---|
| FCFE | $150,000 |
| Constant growth rate | 0.10 |
| Risk-free rate | 0.02 |
| Beta | 1.3 |
| Market return | 0.18 |
| The market value of debt | $2,000,000 |
Calculate:
- Cost of equity
- Value of equity using FCFE
- Value firm using the value of equity
To calculate the cost of equity, we’ll use the below formula:
Cost of equity = Risk free rate + Beta * (Market return - Risk-free rate)
= 0.02 + 1.3 * (0.18 - 0.02)
= 0.2280
To calculate the value of equity, we’ll use the below formula:
Value of equity = (FCFE * (1 + Constant growth rate))/ (Cost of equity - Constant growth rate)
= ($150,000 * (1 + 0.10))/ (0.2280 - 0.10) = $165,000/ 0.1280
= $1,289,063
To calculate the value of the firm, we’ll use the below formula:
Value of firm = Value of equity + Market value of debt
= $1,289,063 + $2,000,000
= $3,289,063
Value of equity using the DCF model where cash flow is FCFE,
Value of equity = (FCFE in year 1/(1 + Cost of equity)1) + (FCFE in year 2/(1 + Cost of equity)2) +...+ (FCFE in year T/(1+ Cost of equity)T)
Let’s take a look at an example:
| Particulars | Amount |
|---|---|
| FCFE in Year 1 | $900,000 |
| FCFE in Year 2 | $1,000,000 |
| FCFE in Year 3 | $1,200,000 |
| Cost of equity | 0.1250 |
To calculate the value of equity, we’ll use the below formula:
Value of equity = (FCFE in year 1/(1 + Cost of equity)1) + (FCFE in year 2/(1 + Cost of equity)2) + (FCFE in year 3/(1 + Cost of equity)3)
= ($900,000/ (1+0.1250)1) + ($1,000,000/ (1 + 0.1250)2) + ($1,200,000/ (1 + 0.1250)3)
= $800,000 + $790,123 + $842,798
= $2,432,921
How To Calculate FCFE From EBITDA FAQs
Yes, FCFE can also be negative.
A negative FCFE indicates that the firm cannot pay its common shareholders and needs to raise more funds.
FCFE from the EBITDA formula is based on EBITDA, Interests, Taxes, Change in working capital, Capital expenditures, and Net borrowing.
An increase in EBITDA will increase FCFE, whereas a decrease in EBITDA will also decrease FCFE.
An increase in interest will reduce FCFE as more cash will be paid to debtholders as interest before equity shareholders are paid any amount of free cash. A decrease in interest will increase FCFE, and a reduction in interest will increase FCFE.
A tax increase will reduce FCFE as the company has more tax liability, and less cash will be available to equity holders. A decrease in taxes will increase FCFE.
An increase in change in working capital will reduce FCFE, and a decrease in change in working will increase FCFE.
Increasing capital expenditures will reduce free cash available to the firm’s equity holders. Decreasing capital expenditures will instead increase FCFE as fewer fixed assets will be purchased, and there will be less use of cash or less FCInv made.
Increasing net borrowing will increase FCFE and vice versa.
A significant debt borrowing or debt obligation of a firm will increase its interest obligation, increasing interest to be paid and reducing FCFE to decrease.
The firm’s higher profitability can result in higher income taxes, reducing free cash available to the firm’s equity shareholders.
FCFE is a measure of cash flow and can be used in valuing equity, valuing the firm, ratio analysis, and discounted cash flow model.
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