What is FCFE (Free Cash Flow to Equity)?
FCFE or Free Cash Flow to Equity is one of the Discounted Cash Flow valuation approaches (along with FCFF) to calculate the Fair Price of the Stock. It measures 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, Free Cash Flow to Equity model is very similar to the dividend discount model (which directly calculates Equity Value of the firm). Unfortunately, the FCFE model has various limitations like the 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.
In this article, we discuss the following –
 FCFE Formula
 FCFE Example in Excel
 Determining the Stock Price using FCFE Model – Alibaba IPO Case Study
 When to use FCFE model?
 What is Negative FCFE?
 How FCFE is different from Dividends?
Most Important – Download FCFE Excel Template
Learn to Calculate FCFE in Excel along with Alibaba FCFE Valuation
FCFE Formula
Free Cash Flow to Equity Formula starting with Net Income
FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings
FCFE Formula  Additional Comments 
Net Income 

(+) Depreciation & Amortization 

(+/) Changes in Working Capital 

() Capex 

(+/) Net Borrowings 

Free Cash Flow to Equity Formula Starting from EBIT
FCFE Formula = EBIT – Interest – Taxes + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings
Free Cash Flow to Equity Formula Starting from FCFF
FCFE Formula = FCFF – [ Interest x (1tax)] + 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 Free Cash Flow to Equity for 2016
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.
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 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
Free Cash Flow to Equity for 2016 comes out to be as per below –
As we note from above, calculating Free Cash Flow to Equity is fairly straightforward!
Why don’t you calculate the Free Cash Flow to Equity using the other two FCFE formulas – 1) Starting with EBIT 2) Starting with FCFF?
Determining the Stock Price using Free Cash Flow to Equity
In one of my earlier financial modeling analysis in excel, I did a 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 Free Cash Flow to Equity example below.
Step 1 – Please prepare a full integrated financial model for Alibaba.
To learn Financial Modeling, you can refer to 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 the 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)
Step 3 – Find the present value of explicit forecast Free Cash Flow to Equity
 In order to find the value of Alibaba from 20152022, 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 Free Cash Flow to Equity methodology. To learn more about Cost of Equity, please refer to Cost of Equity CAPM
 Here, you can use the NPV formula to easily calculate the NPV.
Step 4 – Find Terminal Value
 The terminal value here will capture the perpetuity value after 2022.
 The formula for Terminal value using Free Cash Flow to Equity is FCFF (2022) x (1+growth) / (Keg)
 The growth rate is the perpetuity growth of Free Cash Flow to Equity. In our model, we have assumed this growth rate to be 3%.
 Once you calculate the Terminal Value, then find the present value of the Terminal Value
Step 5 – Find the Present Value
 Add the NPV of an explicit 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 an 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
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.
Where can you use FCFE?
Damodaran advises that Free Cash Flow to Equity can be used under the following conditions –
1) Stable Leverage – As seen in this graph below, Starbucks and Kellogs have volatile Debt to Equity Ratio and hence, we cannot apply the FCFE valuation model in these companies. However, CocaCola and P&G have relatively stable Debt to Equity Ratio. In such cases, we can apply the FCFE model to value the firm.
source: ycharts
2) Dividends not available or Dividends are very different from Free Cash Flow to Equity – 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 the FCFE valuation model for such companies.
What is Negative FCFE?
Like Net Income, Free Cash Flow to Equity can also be negative. Negative FCFE can happen due to any or a combination of the factors below –
 Company is reporting huge losses (Net Income is largely negative)
 the company makes huge capital expenditure resulting in Negative FCFE
 Changes in working capital resulting in an outflow
 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.
How dividends is different from Free Cash Flow to Equity
You can think of FCFE as “Potential Dividends” instead of “Actual Dividends”
Dividends
 A part of the earnings each year may pay to the shareholder’s (dividends payout) and the remaining amount is retained by the company for future growth.
 Dividends depend on the dividends payout ratio and mature/stable companies do try to follow a stable dividend policy.
Free Cash Flow to Equity
 It 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 noncash items like depreciation and amortization. Thereafter, the Capital expenditure required for the company’s growth is subtracted. In addition, changes in working capital are also accounted for so as to successfully run the business in the operating year. Lastly, net borrowings (can be negative or positive) are added.
 Free Cash Flow to Equity is, therefore “Potential Dividends” (leftover after all the stakeholder’s have been taken care of)
Free Cash Flow to Equity Video
Recommended Articles
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!
 Example of Dividend Policy
 Importance of SG&A Expenses (Selling, General & Administrative)
 Cost of Capital Formula in Excel
 Methods to Calculate the Cost of Equity Formula
 FCFF
 Dividend Discount Model DDM
 Weighted Average Cost of Capital Formula
 formula for Cost of Equity
 CAPM Beta Calculation
 DCF Mistakes
 Box Valuation
 Terminal Value Calculation
Alex says
Hi Sir, I wonder if FCFE should include refinancing from new equity issuance just as it includes net borrowing?
Dheeraj Vaidya says
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.
Albert Benny says
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?
Thanks,
Albert
Dheeraj Vaidya says
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.
Thanks,
Dheeraj
Than Aung says
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Dheeraj Vaidya says
Thanks Than. I am happy that you found this useful.
Best,
Dheeraj
Minh Quang says
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Dheeraj Vaidya says
You are welcome!
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Dheeraj Vaidya says
thanks Ramesh!
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Dheeraj Vaidya says
Thanks Sandeep. I am glad you find these articles useful.
Best,
Dheeraj
Fay says
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Dheeraj Vaidya says
Many thanks Fay!
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Dheeraj Vaidya says
Hey Rakesh,
Not yet started writing on LBO Modeling. Will update you on this shortly.
Thanks,
Dheeraj
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Dheeraj Vaidya says
thanks Ankit!
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Dheeraj Vaidya says
thanks Joel! I am glad you like the blog.
Best,
Dheeraj