The superiority of FCFF over EVA and FCFE in capital budgeting

Bibliographic Data

ID15068509
AuthorsPaweł Mielcarz (0000-0002-3986-1858, Kozminski University), Franjo Mlinarič (0000-0002-7480-3119, University of Maribor)
Year2014
Volume27
Issue1
Pages559-572
Publication date2014-01-01
Open AccessYes
TypeARTICLE
VenueEconomic Research-Ekonomska Istraživanja (JOURNAL)
Journal identifiersISSN: 1331-677X • E-ISSN: 1848-9664
PublisherInforma UK Limited (PUBLISHER • GB)
DOI10.1080/1331677x.2014.974916
OpenAlexW1967868043
LanguageEN
Citations received1
References cited20

Misapplication and misinterpretation of capital budgeting techniques can lead to serious capital allocation and capital structure problems. Mainstream literature suggests at least ten approaches for free cash flow and discount rate estimation (leading to the same net present value – NPV) but their benefits vary a lot. We emphasise the application risks when using these techniques without considering the cost of capital for the whole company, thus leading to value decreasing investment decisions. A comparative analysis with a classical free cash flow to equity (FCFE) and economic value added (EVA) methodology will make a strong case for free cash flow to firm (FCFF) as the most efficient approach. We also shed additional light on the main risks associated with the FCFE technique and project-based weighted average cost of capital (WACC) in the capital budgeting process

Business · Capital budgeting · Capital formation · Cash flow · Cost of capital · Cost of equity · Discounted cash flow · Economic Value Added · Economics · Financial capital · Fixed capital · Free cash flow · Microeconomics · Net present value · Project appraisal · Weighted average cost of capital · Capital Investment and Risk Analysis · Corporate Finance and Governance · Financial Reporting and Valuation Research · Finance

Tools

Open DOISci-HubOpen Access