FCFF vs FCFE: Which Cash Flow and Which Discount Rate
By Devon Coombs, CPA, MBA · Teaching Professor of Finance, Santa Clara University · Reviewed August 2026
Use FCFF discounted at WACC when valuing the whole enterprise, and FCFE discounted at the cost of equity when valuing the equity directly. FCFF is cash available to all capital providers, built from EBIT after tax before any financing flows; FCFE is cash available to shareholders after interest and net borrowing. Discounting a firm-level cash flow at an equity rate, or the reverse, produces a number with no economic meaning.
| Free Cash Flow to the Firm (FCFF) | Free Cash Flow to Equity (FCFE) | |
|---|---|---|
| Claim holders | All capital providers, debt and equity | Common shareholders only |
| Starting point | EBIT x (1 - tax rate) | Net income |
| Interest expense | Excluded, pre-financing | Reflected through net income |
| Net borrowing | Not included | Added when raised, subtracted when repaid |
| Discount rate | WACC | Cost of equity |
| Output | Enterprise value | Equity value |
When Free Cash Flow to the Firm (FCFF) is the right tool
FCFF is generally the safer default, and it is the standard choice when leverage is changing, when the debt structure is complex, or when comparing companies with different capital structures. Because it is computed before financing, the forecast does not depend on modeling future borrowing, which is difficult to do credibly. The result is enterprise value, so reaching a price per share still requires subtracting net debt and other non-equity claims.
When Free Cash Flow to Equity (FCFE) is the right tool
FCFE suits situations where leverage is stable and the analyst wants equity value in one step, and it is close to unavoidable for banks and other financial firms, where debt functions as raw material rather than financing. The measure is sensitive to the net borrowing line, since planned debt issuance flows straight into cash available to equity. A forecast that leans on rising borrowing to lift FCFE deserves scrutiny, because it is handing shareholders borrowed money rather than operating cash.
The common mistake
Modelers tend to blend the two definitions, starting from net income while forgetting net borrowing, or subtracting interest from a cash flow that began at EBIT, and then pairing the hybrid with whichever discount rate is at hand. The two measures reconcile through one bridge, FCFE equals FCFF minus after-tax interest expense plus net borrowing, and a model whose firm and equity cash flows do not tie through that identity contains an error somewhere. The discount rate check is just as mechanical; WACC belongs with FCFF and enterprise value, and the cost of equity belongs with FCFE and equity value.
Work the numbers yourself
Both concepts are taught in depth, with practice questions, in the free Entrepreneurial Finance course.