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1. When computing FCFE, we remove the effects of the debts to get pure equity cashflow.
2. When computing the ‘base NPV’ for APV calculations, we also remove the effects of financing costs/debts.
Does that mean that FCFE and base NPV is actually the same thing?
Thanks in advance!
1. Yes
2. No. It is completely different. We calculate the base case NPV as if they were completely equity financed and then adjust separately for the tax benefit of the debt.
I do explain this in my free lectures.
Dear sir,
1. Why is it different if both of them remove the elements of debt to get pure equity? I am referring to FCFE and base NPV (without adjusting for financing costs yet)?
I am wondering if adding effects of financing costs to FCFE makes it an adjusted APV…..2. While we are on this topic, I am going to ask quite a basic question that I couldn’t understand for quite long, hope you don’t mind.
There are times in question when we have to value a company and the information they give are revenue, costs, depreciation…etc, with the cashflow growing at 3.5% perpetuity. So usually the steps to do these will be:
(i) Compute profit after tax (FCF)
(ii) use formula FCF(1+g)/(discount rate – g) = MV of equity (market share price x no of shares)In (ii), why is it that the answer we get is ‘MV of equity’ instead of ‘MV of equity + debt (value of firm’?
Or is it that FCF can be either FCFE or FCFF depending on what we computed for our profit after tax?I know it’s a weird question/way to ask but I am troubled by it for quite a while and couldn’t find anything that is similar.
Thanks in advance!
Discounting the free cash flows to the firm at the WACC gives the MV of the firm (debt + equity). If there is constant growth then using the formula with the free cash flow to the firm and the WACC is doing the discounting.
Discounting the free cash flows to equity at the cost of equity fives the MV of equity. If there is constant growth then using the formula with the free cash flow to equity and the cost of equity is doing the discounting.
Have you watched my free lectures on this?
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