Chartered Financial Analyst (CFA) Level 1 Practice Exam

What does FCFE stand for in financial analysis?

1. Free cash flow to earnings

2. Free cash flow to equity

3. Fixed cost to equity

4. Future cash flow expectations

The correct answer is: Free cash flow to equity

FCFE stands for Free Cash Flow to Equity, which is a crucial metric in financial analysis that measures the cash available to equity shareholders after all expenses, reinvestment, and debt repayments have been accounted for. This metric provides valuable insights to investors and analysts regarding the profitability and cash-generating ability of a company specifically for its equity holders. Free Cash Flow to Equity is calculated by taking the company's operating cash flow, subtracting capital expenditures, and accounting for net debt repayments. The result indicates how much cash can be distributed to shareholders in the form of dividends or share buybacks, making it a critical indicator of a company's financial health and its capacity to create shareholder value. Understanding FCFE is essential, especially for equity investors, as it directly relates to the returns they might expect from their investments. A positive FCFE suggests that a company is in a good position to return cash to its shareholders, while a negative FCFE may signal financial difficulties or a need for more capital investment, potentially jeopardizing shareholder returns. The other options do not accurately represent the concept of FCFE. For example, "Free cash flow to earnings" misrepresents the relationship between cash flow and earnings, while "Fixed cost to equity" and "Future cash flow expectations"