What is the difference between free cash flow to the firm (FCFF) and free cash flow to equity (FCFE)?

• A. FCFF is cash available to all capital providers after operating costs and capex; FCFE is cash available to equity holders after debt service and net borrowings.
• B. FCFF is cash to equity holders; FCFE is cash to all providers
• C. FCFF equals net income
• D. FCFE equals free cash flow before taxes

Answer: (D)

The difference hinges on whose cash flow you’re measuring and what financing actions have been treated as already decided. Free cash flow to the firm (FCFF) is the cash flow generated by the firm’s operations that is available to all capital providers—both debt and equity—after paying operating costs, taxes, and the reinvestment needs of the business (capital expenditures and working capital changes). It excludes debt payments because those are financing activities, not operating ones, and it’s typically used to value the firm as a whole (discounted at the WACC).

Free cash flow to equity (FCFE) is the cash flow that remains available specifically to equity holders after the firm has met its debt obligations and after accounting for net new borrowing. In other words, FCFE reflects financing decisions: it takes FCFF, subtracts after-tax interest, and adds net borrowing (new debt minus debt repayments). This makes FCFE a measure tied to equity value (discounted at the cost of equity).

So the best description is that FCFF is cash available to all capital providers after operating costs and capex, while FCFE is cash available to equity holders after debt service and net borrowings. The other statements miss the distinction: FCFF is not cash to equity holders alone, FCFE is not cash to all providers, FCFF does not equal net income, and FCFE is not a pre-tax measure.