These formulas are essential knowledge for the CFA Level 2 exam and any candidate needs to memorize them. Unfortunately, the way they are presented in the text makes them very difficult to memorize. The key to remembering them is to reorganize them, to get all the things that are added on one side, and all the things that get subtracted on the other. Then, remember that:
- FCFF uses Interest(1-t) and FCFE uses net borrowing.
- From EBIT or EBITDA, you can only get FCFF. Thus, those formulas use Interest(1-t) and do not have net borrowing.
From Net Income:
- FCFF = NI + NCC + Int(1-t) – WCinv – FCinv
- FCFE = NI + NCC + net borrowing – WCinv – FCinv
- CFO = NI + NCC – WCinv
From EBIT or EBITDA:
- FCFF = EBIT(1-t) + NCC – WCinv – FCinv
- FCFF = EBITDA(1-t) + NCC(t) -WCinv – FCinv
- (These formulas have four terms, just like EBIT has four letters. Remember that you can only get FCFF from EBIT or EBITDA.)
- FCFF = CFO + Int(1-t) – FCinv
- FCFE = CFO + net borrowing – FCinv
- (These formulas have three terms, like CFO has three letters. These are the exact same formulas as above for NI, just with the CFO formula condensed.)
- FCFE = FCFF – Int(1-t) + net borrowing
- (For all the formulas above, the translation you made to convert from FCFF to FCFE was to take out (subtract) Int(1-t) and replace it with (add) net borrowing, right? So do the same here.)
With Target Debt Ratio:
- FCFE = NI – (1 – DR)(FCinv – dep) – (1 – DR)(WCinv)
- (Remember that this one is only for FCFE, not FCFF. Note that you are subtracting everything in this formula; there are no plus signs. Where, in the formulas above, do we subtract? Only when we are dealing with FCinv or WCinv. Also subtract dep from FCinv because the only kind of capital that would be depreciated is fixed capital.)
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FCFF = EBIT(1-t) + NCC – WCinv – FCinv This formula is missing depreciation which should be added back.
The correct formula is:
FCFF = EBIT(1-t) + Dep +NCC – WCinv – FCinv
depreciation is a non-cash charge.
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