How do you calculate Free Cash Flow to Equity (FCFE) from a model?

• A. FCFE = CFO - capex.
• B. FCFE = CFO - capex + net debt issued (debt issued minus repayments).
• C. FCFE = Net income - dividends.
• D. FCFE = CFO + net debt issued.

Answer: (B)

FCFE represents the cash that could be distributed to equity holders after the company has generated cash from operations, funded its ongoing investment needs, and handled financing decisions. In a model, the practical way to capture that is to start with cash flow from operations, subtract the capital expenditures needed to maintain or grow the asset base, and then adjust for financing activity that changes cash available to shareholders. Net debt issued (debt issued minus repayments) reflects borrowing or repaying that affects cash; when a company issues debt, it brings in extra cash that can be used for equity, while debt repayments reduce cash. Adding net debt issued to CFO minus capex gives you the cash flow available to equity holders after all three areas—operating performance, investment needs, and financing decisions—have been considered.

For example, if cash flow from operations is 100, capital expenditures are 40, and net debt issued is 20, FCFE would be 80. If instead debt was repaid by 30, net debt issued would be -30 and FCFE would drop accordingly to 30.

The other formulas miss key pieces. Subtracting capex from CFO ignores financing effects on cash available to shareholders; using net income minus dividends relies on accounting profits rather than actual cash flow and distributions; and adding net debt issued to CFO without subtracting capex ignores the reinvestment cash that must be used to sustain the business.