n NISM Certifications
XV NISM Series XV
Medium

In which situations is Free Cash Flow to the Firm (FCFF) used for valuation? FCFF is typically applied when Free Cash Flow to Equity (FCFE) is negative or when a company’s capital structure is likely to change significantly. This approach allows valuation independent of leverage and provides a more accurate assessment when equity cash flows are unreliable.

Practice question from NISM XV Mock Test 2 — bank. The correct answer is highlighted below with a full explanation.

Options

  1. A

    When Free Cash Flow to Equity (FCFE) is negative

  2. B

    When FCFE is positive

  3. C

    When the firm’s capital structure is likely to change significantly

  4. Both options 1 and 3

    Correct answer

Why this is the answer

FCFF is preferred over FCFE when the latter is negative due to debt repayments or reinvestment needs, or when the company plans major changes in debt structure. FCFF reflects cash flows available to all capital providers and is discounted at WACC, making it suitable for valuation in these situations.

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NISM XV Mock Test 2