Advanced Financial Management · Security Valuation

Free Cash Flow and Value-Based Valuation (FCFF, FCFE, EVA, MVA)

Q: What is the difference between FCFF and FCFE?

FCFF is the cash available to all providers of capital, before interest and debt flows. FCFE is what is left for shareholders after interest, tax and net borrowing. FCFF is discounted at WACC to get firm value. FCFE is discounted at Ke to get equity value.

Q: How do I calculate free cash flow to equity?

Start with PAT, add depreciation, deduct capex and the increase in NWC, then add net borrowing. You can also start from FCFF, deduct interest net of tax and add net borrowing. Both routes give the same answer.

Q: Do I subtract debt when I use FCFE?

No. FCFE is already after interest and debt repayments and new borrowings, so discounting it gives equity value directly. Subtract debt only when you start from FCFF.

Q: How are EVA and MVA connected?

EVA is the yearly surplus of NOPAT over the capital charge. MVA is the market value of the firm less the capital invested. In theory, MVA equals the present value of all future EVAs, so a firm that keeps earning positive EVA builds a higher MVA.

Q: Can I use the terminal value formula if growth is higher than the discount rate?

No. The constant-growth formula works only when g is less than the discount rate. If a question gives such figures, check your rate or treat that period as an explicit forecast year instead.

Updated 5 October 2026 · Fact-checked

Free cash flow valuation discounts the cash a business can pay out. FCFF is cash available to all capital providers, discounted at WACC to get firm value; subtract debt for equity value. FCFE is cash left for shareholders, discounted at cost of equity. EVA is NOPAT minus a capital charge; MVA is market value minus capital invested.

Understand Free Cash Flow and Value-Based Valuation

A business is worth the present value of the cash it can hand over to its investors. Profit is an accounting number. Free cash flow is the cash left after the business has paid tax, spent on capex and funded its working capital needs. That is why these methods use cash, not profit.

There are two versions. FCFF (free cash flow to the firm) is the cash available to both lenders and shareholders, before any payment of interest. You discount it at WACC and you get the value of the whole firm. To reach equity value, subtract the market value of debt (and add surplus non-operating cash if the question gives it).

FCFE (free cash flow to equity) is the cash left for shareholders after interest, tax and net borrowing. You discount it at the cost of equity (Ke) and you get equity value directly. The rule: the cash flow and the discount rate must match. FCFF goes with WACC. FCFE goes with Ke.

Most questions have an explicit forecast period and then a terminal value that assumes steady growth (g) forever. The terminal value is usually the biggest part of the answer, so apply the growth formula carefully.

EVA and MVA look at value creation. EVA says: did the business earn more than the charge for all the capital it uses? It is NOPAT less a capital charge at WACC. MVA compares what the market says the capital is worth with what investors put in. A positive EVA stream builds a positive MVA. In theory, MVA equals the present value of all future EVAs.

Key rules to remember

FCFF from EBIT: FCFF = EBIT(1 – t) + Depreciation – Capex – Increase in NWC; EBIT(1 – t) is NOPAT. Use the increase in net working capital; a decrease is added back.
FCFF from operating cash flow: FCFF = CFO + Interest(1 – t) – Capex; Use when cash flow from operations is given after interest. Add back interest net of tax.
FCFE from FCFF: FCFE = FCFF – Interest(1 – t) + Net borrowing; Net borrowing = new debt raised – debt repaid.
FCFE from PAT: FCFE = PAT + Depreciation – Capex – Increase in NWC + Net borrowing; If preference dividend is paid, subtract it too.
Firm value (FCFF): Firm value = Σ FCFFt ÷ (1 + WACC)^t + TV ÷ (1 + WACC)^n; Discount at WACC.
Terminal value: TV at year n = FCFF(n+1) ÷ (WACC – g) = FCFF(n) × (1 + g) ÷ (WACC – g); Valid only when g < WACC. For FCFE, use Ke instead of WACC.
Equity value from FCFF: Equity value = Firm value – Market value of debt (+ non-operating cash); Divide by the number of shares for value per share.
Equity value (FCFE): Equity value = Σ FCFEt ÷ (1 + Ke)^t + TV(equity) ÷ (1 + Ke)^n; Debt is not subtracted, since FCFE is already after debt flows.
EVA: EVA = NOPAT – (WACC × Capital employed) = EBIT(1 – t) – WACC × Capital employed; Use the capital employed the question specifies (opening, if stated). Cost of capital is the after-tax WACC.
MVA: MVA = Market value of firm (equity + debt) – Capital invested; Also equals the present value of all future EVAs.

How to solve Free Cash Flow and Value-Based Valuation questions

Use this order for any FCFF, FCFE, EVA or MVA question. It keeps the cash flow, the discount rate and the claim being valued consistent.

1Read what is asked: firm value, equity value, value per share, EVA or MVA. This decides the cash flow and the discount rate.
2Pick the pair: FCFF with WACC for the firm, FCFE with Ke for equity. Never mix them.
3Build each year's free cash flow from the data. Write out every line: NOPAT or PAT, depreciation, capex, change in NWC, net borrowing.
4Compute the discount rate if it is not given. WACC uses after-tax cost of debt and the weights the question gives.
5Find the terminal value with the growth formula at the end of the explicit period. Check g is below the discount rate.
6Discount every flow and the terminal value. Add them. Keep at least three decimals until the last step.
7Convert to the answer asked: subtract debt for equity value from FCFF, or divide by shares for value per share. For EVA, deduct the capital charge from NOPAT. For MVA, deduct capital invested from market value.
8State the conclusion in one line: compare value with market price, or say whether EVA is positive or negative.

Quickest way: Match, build, discount, convert

When to use it: Use when time is short, especially in a case-scenario MCQ with a single-stage valuation.

Match: FCFF with WACC gives firm value; FCFE with Ke gives equity value.
Build the next year's cash flow only. Write it as NOPAT + Dep – Capex – ΔNWC (or the FCFE version).
For a constant growth case, value = next year's cash flow ÷ (rate – g). That is one line of work.
If a forecast period is given, discount each year with a quick table of (1 + r)^t and add TV discounted by the last factor.
Convert: less debt for FCFF, per share for both. For EVA, compute NOPAT less WACC × capital and stop.

Common mistakes in Free Cash Flow and Value-Based Valuation

Discounting FCFF at the cost of equity, or FCFE at WACC.
Students remember the formula but not what each cash flow includes.
Fix: Say it aloud: FCFF is before debt payments, so it needs WACC. FCFE is after debt payments, so it needs Ke.
Forgetting to subtract debt after valuing the firm with FCFF.
The PV sum feels like the final answer.
Fix: Whenever FCFF is the cash flow, the PV sum is firm value. Always write the line 'Less: debt' before dividing by shares.
Adding back depreciation but ignoring capex, or using the total working capital instead of its change.
Students rush through the cash flow build.
Fix: Use the same four-line layout each time and tick every item given in the question. Only the increase in NWC is deducted.
Using the terminal value formula with the wrong year's cash flow.
Confusion between FCFn and FCFn+1.
Fix: TV = FCF(n) × (1 + g) ÷ (r – g). Discount it with the factor for year n, not year n+1.
Using the pre-tax cost of debt in WACC or in EVA.
The cost of debt given in the question is usually pre-tax.
Fix: Multiply by (1 – t) before weighting. In FCFE, interest is also taken net of tax when moving from FCFF.
Treating EVA and MVA as the same thing.
Both measure value creation.
Fix: EVA is a one-year income measure (NOPAT less capital charge). MVA is a stock measure (market value less capital invested).

Worked examples

Example 1

Case: Ravi Components Ltd has Year 1 EBIT of ₹150 crore, tax rate 30%, depreciation ₹40 crore, capex ₹35 crore, and an increase in NWC of ₹10 crore. FCFF for Year 2 is expected to be ₹110 crore. From Year 3 onwards, FCFF will grow at 5% a year forever. WACC is 10%. The market value of debt is ₹400 crore. There are 10 crore shares. Find the value per share.

Show the solution

Year 1 FCFF: NOPAT = 150 × (1 – 0.30) = ₹105 crore. FCFF = 105 + 40 – 35 – 10 = ₹100 crore.
Terminal value at end of Year 2 = FCFF3 ÷ (WACC – g) = 110 × 1.05 ÷ (0.10 – 0.05) = 115.5 ÷ 0.05 = ₹2,310 crore.
PV of Year 1 FCFF = 100 ÷ 1.10 = ₹90.909 crore.
PV of Year 2 FCFF = 110 ÷ 1.21 = ₹90.909 crore.
PV of terminal value = 2,310 ÷ 1.21 = ₹1,909.091 crore.
Firm value = 90.909 + 90.909 + 1,909.091 = ₹2,090.909 crore.
Equity value = 2,090.909 – 400 = ₹1,690.909 crore.
Value per share = 1,690.909 ÷ 10 = ₹169.09.

Answer: Value per share is about ₹169.09. Firm value is ₹2,090.91 crore and equity value is ₹1,690.91 crore.

Example 2

Case: Meera Foods Ltd has capital employed of ₹1,000 crore: debt ₹400 crore at 10% pre-tax and equity ₹600 crore with cost of equity 15%. EBIT is ₹300 crore and the tax rate is 30%. The market value of the firm (equity plus debt) is ₹1,500 crore. Compute WACC, EVA and MVA, and comment.

Show the solution

After-tax cost of debt = 10% × (1 – 0.30) = 7%.
WACC = (400 ÷ 1,000) × 7% + (600 ÷ 1,000) × 15% = 2.8% + 9.0% = 11.8%.
NOPAT = 300 × (1 – 0.30) = ₹210 crore.
Capital charge = 11.8% × 1,000 = ₹118 crore.
EVA = 210 – 118 = ₹92 crore.
MVA = Market value of firm – Capital invested = 1,500 – 1,000 = ₹500 crore.
Comment: EVA is positive, so the firm earns more than its cost of capital. The positive MVA shows the market expects this to continue.

Answer: WACC = 11.8%, EVA = ₹92 crore, MVA = ₹500 crore. The firm is creating value for its investors.

Exam tips

Write the cash flow build as a small table with one line per item. Marks are given for each correct line even if the final number goes wrong.
State the pairing in your answer: 'FCFF discounted at WACC' or 'FCFE discounted at Ke'. It shows the examiner you know the logic.
In an FCFF question that asks for equity value, do not stop at firm value. Deduct debt, and add non-operating cash only if the question gives it.
For EVA, use the capital employed and the cost of capital the question gives. Check whether the question asks for EVA of one year or for a series.
In case-scenario MCQs, look for traps such as pre-tax interest, an NWC decrease, or a terminal growth rate equal to or above the discount rate.

Practice questions from Security Valuation

Free Cash Flow and Value-Based Valuation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Free Cash Flow and Value-Based Valuation: frequently asked questions

What is the difference between FCFF and FCFE?

FCFF is the cash available to all providers of capital, before interest and debt flows. FCFE is what is left for shareholders after interest, tax and net borrowing. FCFF is discounted at WACC to get firm value. FCFE is discounted at Ke to get equity value.

How do I calculate free cash flow to equity?

Start with PAT, add depreciation, deduct capex and the increase in NWC, then add net borrowing. You can also start from FCFF, deduct interest net of tax and add net borrowing. Both routes give the same answer.

Do I subtract debt when I use FCFE?

No. FCFE is already after interest and debt repayments and new borrowings, so discounting it gives equity value directly. Subtract debt only when you start from FCFF.

How are EVA and MVA connected?

EVA is the yearly surplus of NOPAT over the capital charge. MVA is the market value of the firm less the capital invested. In theory, MVA equals the present value of all future EVAs, so a firm that keeps earning positive EVA builds a higher MVA.

Can I use the terminal value formula if growth is higher than the discount rate?

No. The constant-growth formula works only when g is less than the discount rate. If a question gives such figures, check your rate or treat that period as an explicit forecast year instead.