Generally, Investment appraisal is to assess the viability of a project, program or any portfolio decisions and the value they generate for the organization. To evaluate such viability or profitability we use different techniques such as NPV (Net Present Value Method), IRR (Internal Rate of Return), discounted payback period, ARR (Accounting Rate of Return).

In all these techniques, one thing that is common is the use of Discounted Cash Flow. All the above-mentioned techniques use Discounted cash flow in some or other way as the nature of cash flow used.

Now, What is FCF, FCFF and FCFE?

FCF

It is Free Cash Flow recorded by the company, available for company growth, after meeting its operating expenses and CAPEX (assets and capital expenditure). The formula to calculate FCF is =Operating cash flow- Cash flow from Investing activities or Capex.

FCFF

Free Cash Flow to Firm also called Unlevered Free cash flow available to the company, this is a hypothetical figure, say its an estimate what it would be if the firm has no debt.

The formula to calculate FCFF is =Operating cash flow+[Interest*(1-tax)]- Cash flow from Investing activities or Capex.

FCFF is used in Discounted Cash Flow Analysis to arrive at enterprise value or total firm value. Also, it has the highest correlation between the firm’s economic value. FCFF is most common cashflow used for any type of Financial Modelling Valuation.

FCFE

Free Cash Flow to Equity also called Levered Free Cash Flow. It is derived from the statement of cash flows by taking operating cash flow. It only represents the cash flow available to equity investors; hence it only determines Equity value and not the enterprise value. The formula to calculate FCFE is =Operating cash flow- Capex – Debt Repayment +New Debt.

So, if I talk about the type of cash flow used in Investment Appraisal, it is actually discretion of the organizations But according to me, and the description made above FCFF is the most common type of cash flow used in Investment Appraisal as it is not equity valuation but basically it is enterprise valuation. Now, the formula you are using, I interpreted is as under Income generated by an asset (Operating Cash Flow) + Saving (Capital allowances)- Running Costs (Operating Cost). According to my analysis, the said formula is not similar to FCF (free cash flow). I have already outlined the formula for calculating FCF, and the huge difference between the two is the elimination of Capital Expenditure.

Let us begin with an explanation of all:Now, What is FCF, FCFF and FCFE?FCFFCFFFCFE