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ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

Which statement about using free cash flow to equity (FCFE) rather than FCFF to value a company is correct?

FCFE is discounted at the cost of equity. It is the cash available to shareholders after interest and net borrowing flows, so discounting it gives equity value directly, not enterprise value, and no debt deduction is needed.

  1. AFCFE is discounted at the cost of equity because it is after debt servicing and net borrowingCorrect
  2. BFCFE is discounted at the WACC because it includes all capital providers
  3. CFCFE is calculated before interest so the debt must be deducted afterwards
  4. DFCFE valuation gives enterprise value directly

Explanation

FCFE is the cash available to shareholders after interest, tax and net debt flows, so it is discounted at the cost of equity and gives equity value directly. Discounting at WACC mixes bases.

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