Free Cash Flow to Equity - FCFE
What Is Free Cash Flow to Equity (FCFE)?
Free cash flow to equity is a measure of how much cash is accessible to the equity shareholders of a company after all expenses, reinvestment, and debt are paid. FCFE is a measure of equity capital utilization.
Seeing Free Cash Flow to Equity
Free cash flow to equity is made out of net income, capital expenditures, working capital, and debt. Net income is situated on the company income statement. Capital expenditures can be found inside the cash flows from the investing section on the cash flow statement.
Working capital is additionally found on the cash flow statement; be that as it may, it is in the cash flows from the operations section. By and large, working capital addresses the difference between the company's latest assets and liabilities.
These are short-term capital requirements connected with immediate operations. Net borrowings can likewise be found on the cash flow statement in the cash flows from financing section. It is important to recall that interest expense is now remembered for net income so you don't have to add back interest expense.
The Formula for FCFE
What Does FCFE Tell You?
The FCFE metric is frequently utilized by analysts trying to determine the value of a company. This method of valuation acquired fame as an alternative to the dividend discount model (DDM), particularly on the off chance that a company doesn't pay a dividend. Despite the fact that FCFE might compute the amount accessible to shareholders, it doesn't be guaranteed to compare to the amount paid out to shareholders.
Analysts use FCFE to determine assuming dividend payments and stock repurchases are paid for with free cash flow to equity or another form of financing. Investors need to see a dividend payment and share repurchase that is completely paid by FCFE.
Assuming FCFE is not exactly the dividend payment and the cost to buy back shares, the company is funding with one or the other debt or existing capital or giving new securities. Existing capital incorporates retained earnings made in previous periods.
This isn't the very thing that investors need to find in a current or prospective investment, even assuming interest rates are low. A few analysts contend that borrowing to pay for share repurchases when shares are trading at a discount, and rates are generally low is a wise investment. Be that as it may, this is just the case assuming the company's share price goes up from now on.
In the event that the company's dividend payment funds are fundamentally not exactly the FCFE, the firm is utilizing the excess to increase its cash level or to invest in marketable securities. At long last, assuming the funds spent to buy back shares or pay dividends is around equivalent to the FCFE, then, at that point, the firm is paying everything to its investors.
Illustration of How to Use FCFE
Utilizing the Gordon Growth Model, the FCFE is utilized to ascertain the value of equity utilizing this formula:
Where:
- Vequity = value of the stock today
- FCFE = expected FCFE for next year
- r = cost of equity of the firm
- g = growth rate in FCFE for the firm
This model is utilized to find the value of the equity claim of a company and is possibly suitable to utilize on the off chance that capital expenditure isn't essentially greater than depreciation and on the off chance that the beta of the company's stock is close to 1 or below 1.
Features
- Free cash flow to equity is made out of net income, capital expenditures, working capital, and debt.
- A measure of equity cash utilization, free cash flow to equity computes how much cash is accessible to the equity shareholders of a company after all expenses, reinvestment, and debt are paid.
- The FCFE metric is frequently utilized by analysts trying to determine the value of a company.
- FCFE, as a method of valuation, acquired prominence as an alternative to the dividend discount model (DDM), particularly for cases in which a company doesn't pay a dividend.
