Lesson 3 of 11 · All lessons in this module
- Present value models: DDM and FCFEVideo lesson
- Choosing the cash flow: dividends or FCFE
- FCFF, EBITDA and residual income
- Preferred stock and the Gordon growth modelVideo lesson
- Multistage dividend discount modelsVideo lesson
- Growth assumptions for any cash flow: constant, implied and two-stage
- The DCF process: discount rates, terminal values and ranges
- Integrated cases: negative growth and reconciling FCFE with FCFF
- Integrated cases: two-stage FCFF with debt, and the effect of the debt ratio
- Shortcomings of constant and multistage growth models
- Preferred shares: required return and contingency features
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 3 of 11 · 14 min
FCFF, EBITDA and residual income
FCFF measures the cash available to all capital providers and barely moves when financing changes; EBITDA is a pre-tax, pre-investment shortcut that overstates cash; residual income values the profit earned above the cost of equity.
In short
- FCFF = CFO + interest × (1 − t) − capital expenditure = FCFE + interest × (1 − t) − net borrowing.
- With no debt, FCFF = FCFE. With debt held constant, FCFF > FCFE. Heavy net borrowing can push FCFF below FCFE.
- FCFF values the whole firm, is stable when debt assumptions change, and suits controlling investors and changing capital structures.
- FCFF = EBITDA(1 − t) + depreciation × t − capex − ΔWC. EBITDA ignores investment and taxes, is not a GAAP/IFRS measure, and needs a pre-tax discount rate.
- Residual income per share = EPS − × beginning book value per share. It relies on clean surplus accounting and works even when free cash flow is negative.
Unlock this lesson free for 7 days
Create a free account to get 7 days free: every lesson, video and flashcard, and the question bank. No card needed.