This module 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 9 · 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.
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