CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
Compared with an FCFF valuation, an FCFE valuation is most likely to be preferred when the analyst is valuing a company that has:
FCFE is most appropriate when the company has a stable capital structure with a constant target debt ratio, because net borrowing is then predictable. With a changing capital structure, FCFF is generally easier to forecast and use.
- Anegative free cash flow to the firm
- Ba stable capital structure with a constant target debt ratioCorrect
- Ca rapidly changing capital structure
Explanation
With a stable leverage target, FCFE is easier to forecast because net borrowing is predictable. When leverage is changing or FCFE is volatile, FCFF is typically easier to use.
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