What is FCFE (Free Cash Flow to Equity)?
Free cash flow to equity is the total amount of cash available to the investors; that is the equity shareholders of the company, which is the amount company has after all the investments, debts, interests are paid off.
Explained
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 DDM (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.
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 Capex 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
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