Nuts & Bolts of FCFE – Free Cash Flow to Equity

FCFE or Free Cash Flow to Equity model is one of the Discounted Cash Flow approaches (along with FCFF) to calculate the Fair Price of the Stock.

FCFE measure how much “cash” a firm can return to its shareholders and is calculated after taking care of the taxes, capital expenditure and debt cash flows.

In addition, FCFE model is very similar to the dividend discount model (which directly calculates Equity Value of the firm). Unfortunately, FCFE model has various limitations like Dividend Discount Model. For example, it is useful only in cases where the company’s leverage is not volatile and it cannot be applied to companies with changing debt leverage.

FCFE and Debt Ratio

In this article, we discuss the following –


FCFE Formula

FCFE Formula starting with Net Income


FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings

FCFE Formula Additional Comments
Net Income
  • Net Income is after the payment of Interest expense.
  • Net Income can be taken directly from the Income Statement.
  • You can also find this in the the Cash Flow from Operations if the CFO is prepared using the In-direct method
(+) Depreciation & Amortization
  • Add back all the non cash charges
  • Generally this number is found in the Income Statements. In some companies, Deprecation & Amortization head is not given separately as these expense gets included in Cost of Goods Sold, SG&A
  • You can find Depreciation & Amortization figures from the Cash Flow statements (CFO)
(+/-) Changes in Working Capital
  • Please note that this cash be either an outflow or an inflow.
  • Working capital primarily includes Inventory, Receivables, Payables. You may also include accrued liabilities in this formula.
  • Short term debt is not included here in the changes in Working Capital
(-) Capex
  • Critical to determine CapEx levels required to support sales and margins in forecast
  • This number can be most easily located from Cash Flow from Investments.
  • Please note that not only the Capital Expenditure is taken, we must also include “addition to intangibles”.
  • Intangibles become important for software/knowledge based businesses.
(+/-) Net Borrowings
  • Like working capital, this number can also be an outflow or an inflow
  • This includes both the short term debt as well as the long term debt.
  • Be sure to include the net figure i.e. Debt Issued – Debt Repaid.

FCFE Formula Starting from EBIT

FCFE Formula = EBIT – Interest – Taxes + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings

FCFE Formula Starting from FCFF

FCFE Formula = FCFF – [ Interest x (1-tax)]  + Net Borrowings

FCFE Example – Excel

Now that we know what FCFE formula is, let us look at an example to calculate Free Cash Flow to Equity.

In this example below, you are provided with the Balance Sheet and Income Statement of two years – 2015 and 2016. You may download the FCFE Excel Example from here.

Calculate FCFE for 2016

FCFE Example

Solution –

Let us solve this problem using the Net Income FCFE Formula

FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings

1) Find the Net Income

Net Income is provided in the example = $168

2) Find Depreciation & Amortization

Depreciation & Amortization is provided in the Income Statement. We need to add the 2016 Depreciation figure = $150

3) Changes in Working Capital

Below is the calculation for working capital.

  • From the Current Assets, we take Accounts Receivables and Inventory.
  • From Current Liabilities, we include the Accounts Payable.
  • Please note that we do not take Cash and Short Term Debt in our calculations here.

FCFE - Changes in Working Capital

4) Capital Expenditure
  • Capital Expenditure = change in Gross Property Plant and Equipment (Gross PPE) = $1200 – $900 = $300.
  • Please note that this is a Cash impact will be an outflow of 300
5) Net Borrowings

Borrowings will include of both the short term and long term debt

  • Short Term Debt = $60 – $30 = $30
  • Long Term Debt = $342 – $300 = $42
  • Total Net Borrowings = $30 + $42 = $72
FCFE for 2016 comes out to be as per below –

FCFE Calculations


As we note from above, calculating Free Cash Flow to Equity is fairly straightforward!

Why don’t you calculate the FCFE using the other two FCFE formulas – 1) Starting with EBIT 2) Starting with FCFF ?

Determining the Stock Price using FCFE

In one of my earlier financial modeling analysis, I did valuation of Alibaba IPO Valuation. Though the model is now a bit dated, it still is useful atleast from the point of view of learning FCFE and how the stock prices can be found using FCFE methodology.

You can download Alibaba FCFE for following the FCFE example below.

Step 1 – Please prepare a full integrated financial model of Alibaba.

To learn Financial Modeling, you can refer this Financial Modeling Course.

Step 2 – Find Projected FCFE for Alibaba

  • Once you have prepared the financial model, you can prepare the template like below for FCFE calculation.
  • In our case, we use the Net Income FCFE formula.
  • Once you have all the line items projected using financial modeling, it is very simple to link (see below)

Alibaba IPO FCFE Forecasts

Step 3 – Find the present value of explicit forecast FCFE

  • In order to find the value of Alibaba from 2015-2022, you need to find the present value of projected FCFE
  • For finding the present value, we assume that the Cost of Equity of Alibaba is 12%. Please note that I have taken this as a random figure so as to demonstrate FCFE methodology. To learn more about Cost of Equity, please refer to Cost of Equity CAPM
  • Here, you can use NPV formula to easily calculate the NPV.

NPV FCFE Projectsions

Step 4 – Find Terminal Value

  • Terminal value here will capture perpetuity value after 2022.
  • The formula for Terminal value using FCFE is FCFF (2022) x (1+growth) / (Ke – g)
  • Growth rate is the perpetuity growth of FCFE. In our model we have assume this growth rate to be 3%.
  • Once you calculate the Terminal value, then find the present value of the Terminal Value

FCFE Terminal Value

Step 5 – Find the Present Value

  • Add the NPV of explict period and Terminal value to find the Equity Value
  • Please note that when we perform FCFF analysis, the addition of these two items provides us with Enterprise value
  • To the above Equity Value, we add Cash and other investments to find the Adjusted Equity Value
  • Divide the Adjusted Equity Value by total number of shares outstanding to find the Share Price
  • Also, note that my valuation using FCFF approach ($191 billion) and FCFE approach ($134.5 billion) are coming out to be different primarily due to random assumptions of cost of equity (ke) and growth rates of FCFE

Alibaba FCFE DCF

Step 6 – Perform Sensitivity Analysis of Stock Prices.

You can also perform sensitivity analysis in excel of Stock prices on FCFE inputs – Cost of Equity and Growth Rates.

FCFE Sensitivity Analysis

Where can you use FCFE

Damodaran advises that FCFE can be used under the following conditions –

1) Stable Leverage –  As seen in this graph below, Starbucks and Kellogs have volative Debt to Equity Ratio and hence, we cannot apply FCFE valuation model in these companies. However, Coca-Cola and P&G have relatively stable Debt to Equity Ratio. In such cases, we can apply FCFE model to value the firm.

FCFE and Debt Ratiosource: YCharts

2) Dividends not available or Dividends are very different from FCFE – In most of the high growth companies like Facebook, Twitter, etc do not give dividends and hence, Dividend Discount Model can’t be applied. You may apply FCFE valuation model for such companies.

What is Negative FCFE?

Like Net Income, FCFE can also be negative. Negative FCFE can happen due to any or combination of the factors below  –

  1. Company is reporting huge losses (Net Income is largely negative)
  2. Company makes huge capital expenditure resulting in Negative FCFE
  3. Changes in working capital resulting in an outflow
  4. Debt is repaid resulting in large cash outflow

Below is an example where we find Negative FCFE. I had earlier evaluated Box IPO and you can download its Box financial model here.

We note that in Box Inc, the main cause for Negative FCFE is Net Losses.

Box IPO - FCFE Borrowings

How dividends is different from FCFE

You can think of FCFE as “Potential Dividends” instead of “Actual Dividends”

Dividends –
  • A part of the earnings each year may paid to the shareholder’s (dividends payout) and the remaining amount is retained by the company for future growth.
  • Dividends depends on the dividends payout ratio and mature/stable companies do try to follow stable dividend policy.
  • FCFE
  • FCFE is basically the free cash available after all the obligations have been taken care of (think of capex, debt, working capital etc).
  • FCFE starts with Net Income (before the dividends are deducted) and adds all the non cash items like depreciation and amortization. Thereafter, Capital expenditure required for company’s growth is subtracted. In addition, changes in working capital is also accounted for so as to successfully run the business in the operating year. Lastly, net borrowings (can be negative or positive) are added.
  • FCFE is therefore “Potential Dividends” (leftover after all the stakeholder’s have been taken care of)

What next?

If you learned something new or enjoyed the post, please leave a comment below. Let me know what you think. Many thanks and take care. Happy Learning!


    • By Dheeraj Vaidya on

      Hi Alex, that’s an interesting question. What is the impace of new equity issuance on FCFE. The impact is none actually. The real impact comes on the per share value calculated.
      1. new equity issuance means new shares issued.
      2. FCFE is calculated as per the formula given in the post
      3. Present value of FCFE is then dividend by the total number of outstanding shares to calculate the fair value of share.

      Short answer -> equity issuance leads to higher number of shares. Higher number of shares reduces per share value of the stock.


  1. By Albert Benny on

    Hello Sir,

    These are really helpful and amazing. I have a doubt sir, I had once come across an equity report from pubic website which had predictions including future sales(revenue) and costs depending on their expected customers and stuff like that. could you please tell us how do they come to such conclusions regarding such future market predictions and events?

    Do you have any tutorials regarding such predictive models? I mean how to calculate the percentage increase in sales rather than taking an arbitrage vale. Do equity research analysts get access to details regarding the number of customers of a company which help them do more comprehensive analysis?



    • By Dheeraj Vaidya on

      Hi Albert, equity research analyst do a rigourous analysis on the company. All data that they use is publicly available. It’s just that they have to spend more time and energy on making sense from the information. Typical places where they look for relevant data is press releases, conference calls, industry reports, news, annual reports, company filings. In addition, they do have paid access to third party research tools like bloomberg, factiva etc that provide them with data in a structured and phased manner.


  2. By Than Aung on

    Thank you so very much for your effort for providing this with comprehensive explanation. It’s really helpful and so useful.


  3. By Ramesh on

    Very informative. You are indeed doing a yeoman service in disseminating such rich knowledge.

    Many thanks.





  5. By Fay on

    Hi Dheeraj
    You are amazingly generous by sharing these with us.
    I am learning a great deal and enjoy it thoroughly.
    Very grateful.
    Many thanks.


    • By Dheeraj Vaidya on

      Hey Rakesh,

      Not yet started writing on LBO Modeling. Will update you on this shortly.



  6. By Joel Pinto on

    Dear Dheeraj Vaidya Sir,
    I sencerly appreciate you for all your efforts. You are truely fantastic person. Your materials are very easy to understand and very helpful. And unlike others, you aim to educate others and not make money.

    Keep up the good work Dheeraj Sir.


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