Free cash flow to equity
Cash flow from operations less investment in fixed capital, plus net borrowing: what is left for shareholders after operating needs, investment and payments to lenders. Discounted at the cost of equity.
Where you will meet it
Free cash flow to equity appears in 17 learning outcomes on the CFA syllabus. A few of them:
- Explain why free cash flow to equity can serve as the basis of a valuation
“Free cash flow to equity is what could be paid to shareholders after operating expenses, interest, taxes, working capital and capital expenditure, and after net borrowing.”
- Derive FCFF and FCFE, the free cash flows to the firm and to its shareholders, using the cash flow statement
“Free cash flow to equity starts from operating cash flow, subtracts capital expenditure and adds net borrowing.”
- Contrast valuing a business by the free cash flow available to equity (FCFE) with valuing it by its free cash flow to the whole firm (FCFF)
“Free cash flow to equity is what remains for common shareholders after interest, debt repayment and new borrowing; discounting it at the required return on equity values equity directly.”
- Work out and explain how well dividends are covered, measured against free cash flow and against net income
“The cash flow version compares free cash flow to equity with what is actually paid out, usually dividends plus repurchases, because both consume cash.”
See also
Practise it
Practise free cash flow to equity until it is automatic: questions that explain every wrong option.
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