FREE CASH FLOW TO THE FIRM

The free cash flow to the firm (FCFF) is the sum of the cash flows to all claim holders in the firm, including common stockholders, bondholders, and preferred stockholders. There are two ways of measuring the free cash flow to the firm.

One is to add up the cash flows to the claim holders, which would include cash flows to equity (defined either as free cash flow to equity or as dividends); cash flows to lenders (which would include principal payments, interest expenses, and new debt issues); and cash flows to preferred stockholders (usually preferred dividends):

Note, however, that we are reversing the process that we used to get to free cash flow to equity, where we subtracted out payments to lenders and preferred stockholders to estimate the cash flow left for stockholders. A simpler way of getting to free cash flow to the firm is to estimate the cash flows prior to any of these claims. Thus we could begin with the earnings before interest and taxes, net out taxes and reinvestment needs, and arrive at an estimate of the free cash flow to the firm: