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CFA Level II Exam · Free Cash Flow Valuation

Single-Stage Free Cash Flow Valuation Models (FCFF and FCFE)

Updated 7 October 2026 · Fact-checked

A single-stage free cash flow model assumes cash flow grows at a constant rate forever. Firm value = FCFF₁ ÷ (WACC − g). Equity value = FCFE₁ ÷ (r − g). To get equity from firm value, subtract market value of debt (and preferred stock). Divide equity value by shares for value per share.

Understand Single-Stage Free Cash Flow Valuation Models

Free cash flow models value a company by the cash it can pay to its capital providers. FCFF (free cash flow to the firm) is cash available to all providers: debt holders, preferred holders and common shareholders. FCFE (free cash flow to equity) is cash available to common shareholders only, after debt payments and new borrowing.

The single-stage model treats the next cash flow as the starting point and assumes it grows at a constant rate g forever. This is the same idea as the Gordon growth model, but with free cash flow instead of dividends. It fits a mature, stable company whose growth is at or below the long-run growth of the economy.

The discount rate must match the cash flow. FCFF belongs to all capital providers, so you discount it at WACC. That gives firm value. FCFE belongs to shareholders only, so you discount it at the required return on equity (cost of equity). That gives equity value directly.

To move from firm value to equity value, subtract the market value of debt and preferred stock. You may add non-operating assets such as excess cash if they are not already counted. Then divide by shares outstanding.

The two approaches should give similar answers if the assumptions are consistent. They differ when leverage is expected to change. FCFF is often preferred for a company with a changing capital structure or negative FCFE. FCFE is simpler when leverage is stable.

Key formulas to remember

Single-stage FCFF firm value
Firm value₀ = FCFF₁ ÷ (WACC − g) = FCFF₀ × (1 + g) ÷ (WACC − g)
Requires WACC > g. FCFF₁ is next year's cash flow. Check whether the vignette gives FCFF₀ or FCFF₁.
Firm value to equity value
Equity value = Firm value − Market value of debt − Preferred stock (+ non-operating assets if excluded)
Use market value of debt where given. Use the same date as the firm value.
Single-stage FCFE equity value
Equity value₀ = FCFE₁ ÷ (r − g) = FCFE₀ × (1 + g) ÷ (r − g)
r is the required return on equity. Requires r > g.
Value per share
Value per share = Equity value ÷ Shares outstanding
Use the share count the vignette specifies.
WACC
WACC = [E ÷ (D + E)] × rₑ + [D ÷ (D + E)] × r_d × (1 − t)
Use target or market-value weights and the after-tax cost of debt.
FCFE from FCFF
FCFE = FCFF − Interest × (1 − t) + Net borrowing
Net borrowing is new debt issued minus debt repaid.

How to solve Single-Stage Free Cash Flow Valuation Models questions

Use this order for any single-stage free cash flow question in an item set.

  1. 1Identify which cash flow you are valuing: FCFF (firm) or FCFE (equity). Note whether the vignette gives a current (time 0) or next-year (time 1) figure.
  2. 2If needed, compute the cash flow from the exhibit data, for example FCFE = FCFF − Interest × (1 − t) + Net borrowing.
  3. 3Pick the matching discount rate: WACC for FCFF, cost of equity for FCFE. Compute WACC from after-tax cost of debt and the stated weights if it is not given.
  4. 4Grow the cash flow once if you have time 0 data: multiply by (1 + g).
  5. 5Apply the formula: cash flow₁ ÷ (rate − g). Confirm rate is greater than g.
  6. 6For FCFF, subtract debt and preferred stock from firm value to get equity value.
  7. 7Divide equity value by shares for value per share, and compare with market price if asked.
  8. 8Check the answer is reasonable: equity value should be below firm value when debt exists.

Quickest way: Match, grow, divide, subtract

When to use it: Use when the vignette gives a clean growth rate and discount rate and the question asks for a value or value per share.

  1. Circle FCFF or FCFE and the year of the figure.
  2. Multiply by (1 + g) only if the figure is for time 0.
  3. Divide by (rate − g) using WACC for FCFF and cost of equity for FCFE.
  4. Subtract debt and preferred only on the FCFF route.
  5. Divide by shares if per-share value is asked.

Common mistakes in Single-Stage Free Cash Flow Valuation Models

  • Discounting FCFF at the cost of equity, or FCFE at WACC.

    Both rates appear in the exhibit and students pick the more familiar one.

    Fix: Match the rate to the claimants. FCFF goes with WACC. FCFE goes with cost of equity.

  • Forgetting to grow the time 0 cash flow by (1 + g).

    Students copy the Gordon growth shape without checking the cash flow date.

    Fix: Ask whether the figure is current or next year. Use FCFF₀ × (1 + g) if current.

  • Treating FCFF-based firm value as equity value.

    The formula output looks like a final answer.

    Fix: Subtract market value of debt and preferred stock before dividing by shares.

  • Using the before-tax cost of debt in WACC.

    The exhibit lists a pre-tax rate and students skip the tax adjustment.

    Fix: Multiply the cost of debt by (1 − tax rate) in WACC.

  • Subtracting book value of debt when market value is given.

    Both figures appear in the balance sheet and notes.

    Fix: Use market value of debt when the vignette gives it. Use book value only as a stated approximation.

  • Adding back interest tax shield twice when computing FCFE from FCFF.

    Students subtract pre-tax interest or confuse the formula with FCFF from net income.

    Fix: Subtract interest × (1 − t) from FCFF, then add net borrowing.

Worked examples

Example 1

Vignette: Norvik Components plc has FCFF of €80 million this year, expected to grow at 4% a year indefinitely. Its WACC is 9%. It has debt with a market value of €300 million, no preferred stock, and 50 million shares. Q1: What is the firm value? Q2: What is the value per share?

Show the solution
  1. FCFF₁ = 80 × 1.04 = €83.2 million.
  2. Firm value = 83.2 ÷ (0.09 − 0.04) = 83.2 ÷ 0.05 = €1,664 million.
  3. Equity value = 1,664 − 300 = €1,364 million.
  4. Value per share = 1,364 ÷ 50 = €27.28.

Answer: Firm value is €1,664 million. Value per share is €27.28.

Example 2

Vignette: Calder Foods Inc. has FCFF₀ of $120 million, interest expense of $20 million, a tax rate of 30%, and net borrowing of $15 million this year. It has 40 million shares. FCFE is expected to grow at 3% a year. Cost of equity is 8%. Q1: What is current FCFE? Q2: What is the value per share?

Show the solution
  1. After-tax interest = 20 × (1 − 0.30) = $14 million.
  2. FCFE₀ = 120 − 14 + 15 = $121 million.
  3. FCFE₁ = 121 × 1.03 = $124.63 million.
  4. Equity value = 124.63 ÷ (0.08 − 0.03) = 124.63 ÷ 0.05 = $2,492.6 million.
  5. Value per share = 2,492.6 ÷ 40 = $62.315, about $62.32.

Answer: FCFE₀ is $121 million. Value per share is about $62.32.

Exam tips

  • Read the vignette for whether the cash flow is time 0 or time 1. This one detail decides many answers.
  • If an item set gives both WACC and cost of equity, expect a trap. Match the rate to the cash flow.
  • Watch for debt and preferred stock in a separate exhibit or footnote when moving from firm value to equity value.
  • Check that the discount rate exceeds g. If it does not, you have misread an input.
  • Questions may ask why FCFF or FCFE is preferred. Link FCFE to stable leverage and FCFF to changing leverage or negative FCFE.

Single-Stage Free Cash Flow Valuation Models in other exams

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

Single-Stage Free Cash Flow Valuation Models: frequently asked questions

Why do we discount FCFF at WACC and FCFE at cost of equity?

FCFF is paid to all capital providers, so the blended cost of all capital, WACC, is the right rate. FCFE goes only to shareholders, so their required return is the right rate. Mixing them gives a value for the wrong claim.

How do I get equity value from firm value in an FCFF model?

Subtract the market value of debt and any preferred stock from firm value. Add non-operating assets if they were not included in FCFF. Then divide by shares outstanding for value per share.

When is the single-stage model appropriate?

Use it for a mature company with stable growth at or below the long-run economic growth rate and a steady capital structure. For a company with changing growth, use a multistage model.

Do FCFF and FCFE models give the same value?

They should if the assumptions are consistent, but in practice they often differ. Differences arise from changing leverage, different growth estimates, and inconsistent discount rates.