Free cash flow to equity (FCFE) is the cash flow available for distribution to a company’s equity-holders. It equals free cash flow to firm minus after-tax interest expense plus net increase in debt. FCFE is discounted at the cost of equity to value a company’s equity. Free cash flow to equity is one of the two definitions of free cash flow: the other being the free cash flow to firm (FCFF). In general, the term free cash flow refers to the free cash flow to firm.

FCFE differs from FCFF in that the free cash flow to firm is the cash flow that is available for distribution to both the debt-holders and equity-holders while the free cash flow to equity is the cash flow that’s available only for distribution to equity-holders. After-tax interest expense is subtracted from FCFF and net borrowing is added because they represent the cash paid to and cash raised from debt-holders.

This approach is a variation on the Gordon Growth Method. Real cash flows, the real growth rate, and the real required rate of return will be applied to minimize potential distortion caused by inflation and other international differences.

The free cash flow to equity formula may be used by investors and analysts in replace of dividends when analyzing a company. One of the most notable examples of this is in the free cash flow to equity model for valuing a stock. The free cash flow to equity model differs from the dividend discount method only in that it uses free cash flow to equity instead of dividends.

The cost (or return) of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the compensation the market demands in exchange for owning the asset and bearing the risk of ownership.

The Free Cashflow to Equity (FCFE) Single Stage Model assumes that a company's Free Cashflow to Equity is going to continue to rise at a constant growth rate indefinitely. You can use that assumption to figure out what a fair price is to pay for the share or investment today based on those future FCFE payments.

The value of cashflow expected next year or period. Assuming the free cashflow will be the same for this year and accounting for growth (g), the FCFE_{1} value can be calculated by multiplying the value of FCFE this period (FCFE_{0}) by 1+g (growth rate).

FCFE_{1} = FCFE_{0} * (1+g)

The value of Equity to Firm is the value of a firm’s equity today. The value of any share is the present value of the FCFE per year for the extraordinary growth period plus the present value of the terminal price at the end of the period.

The free cash flow to equity model is primarily used in the case of international valuations. The model becomes even more effective when the multinational company also conducts business is some countries which are prone to high inflation.

Consider a firm with a growth rate of 5%, a return on equity of 12% and an FCFE of $500,000 next year. The value for Free Cashflow to Equity for this firm can be calculated with the FCFE Single Stage model as follows:

V = FCFE_{1} / (K_{e} – g)

V = 500,000 / (0.12 – 0.05)

V = $7,142,857.14

The Value of Free Cashflow to Equity for investors for this firm equates to $7,142,857.14 using the FCFE Single Stage model.

Although the free cash flow to equity may calculate the amount available to shareholders, it does not necessarily equate to the amount that is paid out to shareholders.

The free cash flow to equity formula is used to calculate the equity available to shareholders after accounting for the expenses to continue operations and future capital needs for growth. This final value can be used to predict how much of equity may be paid out as dividends to shareholders for dividend issuing companies.

Although the free cash flow to equity may calculate the amount available to shareholders, it does not necessarily equate to the amount that is paid out to shareholders.

To understand the use of the free cash flow to equity formula, one must understand the components of it and how it differs from dividends. A company's net income is also referred to its earnings. A company pays some of the earnings out to investors in the form of dividends and the amount retained is used for future growth. The formula for cash flow to equity starts with the company's earnings. Capital expenditures is subtracted to account for the amount needed for assets used for growth. The next variable, change in working capital, is subtracted to account for an increase in capital needed for short term operations. Lastly, net borrowing is added, or subtracted if negative, to account for any capital received from taking new debt, or lost due to repayment of debt. These factors all resolve to the amount available to equity, or shareholders.

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- See Also:
- DDM,
- FCFE 2 Stage,
- FCFF,