Flow of Equity

Question 1

What is Flow-to-Equity?

Answer 1

A valuation method that calculates the free cash flow available to equity holders taking into account all payments to and from debt holders. The cash flows to equity holders are discounted using the equity cost of capital.

Question 2

Formula for Free Cash Flow to Equity? (FCFE)

Answer 2

FCFE = FCF - (1-tauc)*(Interest Payments) + (Net Borrowing)

Question 3

Advantages of the FTE method?

Answer 3

May be simpler to calculating the value of the equity for the entire firm. May be viewed as a more transparent method for discussing a project’s benefit to shareholders by emphasizing a project’s implication for equity.

Question 4

Comparison of methods (WACC, APV, FTE)?

Answer 4

WACC: easiest when D/E is constant
For alternative leverage policies, the APV method is usually the simplest approach
FTE: when values in the firm’s capital structure or the interest tax shield are difficult to determine