CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models

FCFF and FCFE Formulas and How to Value Them

Updated 7 October 2026 · Fact-checked

FCFF is cash available to all capital providers after tax, capex and working capital investment. FCFE is cash available to shareholders only, after debt service and net borrowing. Compute each from net income, CFO or EBIT, discount FCFF at WACC and FCFE at the cost of equity.

Understand Free Cash Flow to Firm and Equity (FCFF, FCFE)

Free cash flow is cash a company generates after paying for the investment needed to keep and grow the business. It does not depend on dividends paid. That makes it useful when a firm pays no dividend or pays an unusual one.

FCFF (free cash flow to the firm) belongs to everyone who funds the firm: debtholders and shareholders. It is measured before payments to debt and equity providers, so it is not affected by how the firm is financed. You discount it at WACC and get firm value.

FCFE (free cash flow to equity) belongs only to shareholders. It is what is left after interest, after tax, after investment, and after net borrowing (new debt minus repayments). You discount it at the cost of equity and get equity value directly.

The link between them: FCFE = FCFF − Interest × (1 − t) + Net borrowing. Interest is subtracted after tax because interest saves tax. Firm value minus the market value of debt gives equity value from the FCFF route.

On the exam you will be given one starting point (net income, CFO or EBIT) and asked to reach FCFF or FCFE, then often to value with a constant growth model. Pick the right formula for the starting point, and the right discount rate for the cash flow.

Key formulas to remember

FCFF from net income: FCFF = NI + NCC + Int × (1 − t) − FCInv − WCInv; NCC = non-cash charges such as depreciation. FCInv = fixed capital investment (capex minus proceeds from asset sales). WCInv = increase in working capital.
FCFF from CFO: FCFF = CFO + Int × (1 − t) − FCInv; Add Int × (1 − t) whenever interest paid is deducted in CFO: always under US GAAP, and under IFRS if interest paid is classified as operating. If IFRS classifies interest paid as financing, do not add it back.
FCFF from EBIT: FCFF = EBIT × (1 − t) + Dep − FCInv − WCInv; Tax is applied to EBIT, so no interest tax shield is included; that is captured in WACC.
FCFF from EBITDA: FCFF = EBITDA × (1 − t) + Dep × t − FCInv − WCInv; Depreciation only matters through its tax shield.
FCFE from FCFF: FCFE = FCFF − Int × (1 − t) + Net borrowing; Net borrowing = debt issued − debt repaid.
FCFE from net income: FCFE = NI + NCC − FCInv − WCInv + Net borrowing; Interest is already deducted in net income, so do not adjust for it.
FCFE from CFO: FCFE = CFO − FCInv + Net borrowing; CFO already includes interest paid under US GAAP, and under IFRS if interest paid is classified as operating. If IFRS interest paid is in financing activities, subtract Int × (1 − t) from CFO to get FCFE.
Firm and equity value: Firm value = Σ FCFFt ÷ (1 + WACC)^t; Equity value = Σ FCFEt ÷ (1 + r)^t; r is the cost of equity. Equity value from FCFF route = Firm value − market value of debt.
Constant growth valuation: Firm value0 = FCFF1 ÷ (WACC − g); Equity value0 = FCFE1 ÷ (r − g); Needs FCFF1 or FCFE1, the next-period flow, and WACC > g (or r > g).

How to solve Free Cash Flow to Firm and Equity (FCFF, FCFE) questions

Work from what the question gives you to the cash flow you need, then match the discount rate.

1Decide the target: FCFF (firm value, discount at WACC) or FCFE (equity value, discount at cost of equity).
2Identify the starting item: net income, CFO, EBIT or EBITDA. Choose the matching formula.
3List the adjustments: non-cash charges, capex (net of asset sales), increase in working capital, interest after tax, net borrowing.
4Check signs. An increase in working capital reduces cash flow. Capex is subtracted. Net borrowing is added when positive.
5Compute the cash flow for each forecast period. If growth is constant, compute next year's flow as current × (1 + g).
6Discount with the right rate. For a constant growth model use flow1 ÷ (rate − g). For multistage, discount explicit years and add a discounted terminal value.
7If valuing equity from FCFF, subtract the market value of debt from firm value. Divide equity value by shares outstanding if per-share value is asked.

Quickest way: Anchor on the starting line, then fix interest and borrowing

When to use it: Use for any FCFF/FCFE conversion question when time is short.

From CFO: FCFF = CFO + after-tax interest − capex. FCFE = CFO − capex + net borrowing.
From net income: FCFE needs no interest adjustment. FCFF adds after-tax interest.
From EBIT: tax EBIT first, add depreciation, subtract capex and working capital increase.
To jump between them, remember FCFE = FCFF − after-tax interest + net borrowing.
Pick the discount rate by matching: FCFF with WACC, FCFE with cost of equity. Eliminate any option that mixes them.

Common mistakes in Free Cash Flow to Firm and Equity (FCFF, FCFE)

Discounting FCFE at WACC or FCFF at the cost of equity.
Both are called free cash flow and students forget which investors each belongs to.
Fix: FCFF is for all capital providers, so WACC. FCFE is for shareholders only, so cost of equity.
Adding back interest to net income when computing FCFE.
The FCFF formula has an interest term and students copy it across.
Fix: Net income is already after interest, which is a real cash cost to shareholders. Only FCFF adds back Int × (1 − t).
Adding back full interest instead of after-tax interest.
Forgetting that interest is tax deductible.
Fix: Always use Int × (1 − t) when converting between NI, CFO and FCFF.
Getting the sign of working capital wrong.
Mixing up 'increase in working capital' with the cash flow statement line, where an increase appears as a negative.
Fix: An increase in operating working capital uses cash, so subtract it. A decrease adds cash.
Using current-year cash flow in the growth formula instead of next year's.
Rushing and plugging in the number given.
Fix: Value = flow1 ÷ (rate − g). If you are given flow0, multiply by (1 + g) first.
Forgetting to subtract debt after valuing the firm with FCFF.
Stopping once a value is found.
Fix: FCFF gives firm value. Subtract the market value of debt to reach equity value before dividing by shares.

Worked examples

Example 1

A company has net income of $120 million, depreciation of $40 million, interest expense of $30 million, a tax rate of 30%, capex of $90 million, and an increase in working capital of $15 million. Find FCFF. Options: (A) $56 million, (B) $76 million, (C) $96 million.

Show the solution

Use FCFF = NI + NCC + Int × (1 − t) − FCInv − WCInv.
After-tax interest = 30 × (1 − 0.30) = 21.
FCFF = 120 + 40 + 21 − 90 − 15.
120 + 40 = 160; 160 + 21 = 181; 181 − 90 = 91; 91 − 15 = 76.

Answer: B: FCFF = $76 million.

Example 2

A firm's FCFF next year is expected to be €50 million and will grow at 4% forever. WACC is 9%. The market value of debt is €300 million and there are 40 million shares. Find equity value per share. Options: (A) €8.75, (B) €17.50, (C) €25.00.

Show the solution

Firm value = FCFF1 ÷ (WACC − g) = 50 ÷ (0.09 − 0.04) = 50 ÷ 0.05 = €1,000 million.
Equity value = firm value − debt = 1,000 − 300 = €700 million.
Per share = 700 ÷ 40 = €17.50.

Answer: B: €17.50 per share.

Exam tips

Read the first line of the data. If you are given CFO and capex, the answer is usually two or three steps away.
Check which rate is offered. If the stem gives WACC, the flow being valued is almost always FCFF; if it gives cost of equity, it is FCFE.
For numerical options listed small to large, test the sign of the working capital and interest adjustments; wrong options often come from a single sign error.
Always note whether net borrowing is positive or negative; repayments are negative.
Watch the IFRS point: where interest paid is classified as financing, CFO does not already deduct it.

Practice questions from Discounted Cash Flow (DCF) and Growth Models

Free Cash Flow to Firm and Equity (FCFF, FCFE) 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 to Firm and Equity (FCFF, FCFE): frequently asked questions

What is the difference between FCFF and FCFE?

FCFF is cash available to all capital providers, both debt and equity, and is discounted at WACC. FCFE is cash available to shareholders after interest and net borrowing, and is discounted at the cost of equity.

How do I calculate FCFE from net income?

FCFE = Net income + non-cash charges − fixed capital investment − increase in working capital + net borrowing. Net income is already after interest, so you make no interest adjustment.

Why is interest multiplied by (1 − t) in the FCFF formula?

Interest is tax deductible, so the real cost to the firm is the after-tax amount. Adding back only that amount recovers the cash that was actually removed by interest.

When should I use FCFE instead of FCFF?

FCFE is more direct when capital structure is stable and you want equity value straight away. FCFF is often preferred when leverage is changing, because it is independent of financing choices.