Free Cash Flow The focus on traditional financial statements is -Select-marketac

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Free Cash Flow

The focus on traditional financial statements is -Select-marketaccountingreplacementItem 1 data rather than cash flow. However, cash flow is important to investors, managers, and stock analysts. Therefore, decision makers and security analysts need to modify financial statement data provided to them. An important modification is the concept of free cash flow (FCF). Many analysts regard FCF as being the single and most important number that can be developed from the income statements, even more important than net income. The equation for free cash flow is:

FCF = [EBIT(1 - T) + Depreciation and amortization] - [Capital expenditures + ?Net operating working capital]

-Select-NetFreeOperatingItem 2 cash flow is the cash flow actually available for payments to all investors (stockholders and debtholders) after the company has made investments in fixed assets, new products, and -Select-operating working capitalnet working capitallong-term debtItem 3 . A negative FCF means that the company does not have sufficient -Select-externalinternalItem 4 funds to finance its investments in fixed assets and working capital, and that it will have to raise new money in the -Select-spotcapitalexchangeItem 5 markets to pay for these investments. Negative FCF is not always bad. If FCF is negative because after-tax operating income is negative this is bad, because the company is probably experiencing operating problems. Exceptions to this might be startup companies, companies incurring significant expenses to launch a new product line, and high-growth companies—with large capital investments.

Quantitative Problem: Rosnan Industries' 2013 and 2012 balance sheets and income statements are shown below.

The balance in the firm's cash and equivalents account is needed for operations and is not considered "excess" cash.

Using the financial statements given above, what is Rosnan's 2013 free cash flow (FCF)? Use a minus sign to indicate a negative FCF.
$

Balance Sheets: 2013 2012 Cash and equivalents $100   $85   Accounts receivable 275   300   Inventories 375   250         Total current assets $750   $635   Net plant and equipment 2,300   1,490   Total assets $3,050   $2,125   Accounts payable $150   $85   Accruals 75   50   Notes payable 150   75         Total current liabilities $375   $210   Long-term debt 450   290   Common stock 1,225   1,225   Retained earnings 1,000   400   Total liabilities and equity $3,050   $2,125  

Explanation / Answer

EBIT for 2013 = $850

tax rate , T = 40% = 0.40

Net operating profit less adjusted taxes for year 2013 = NOPLAT = EBIT*(1-T) = 850*(1-0.40) = 850*0.60 = $510

Net investment for year 2013 = ( Net plant and equipment for 2013 + Total current assets for 2013 - total current liabilities for 2013) - ( Net plant and equipment for 2012 + Total current assets for 2012 - total current liabilities for 2012)

Net investment for year 2013 = (2300 + 750-375) - (1490+635-210) = 2675 - 1915 = 760

Rosnan's 2013 FCF = NOPLAT for year 2013 - Net investment for year 2013 = 510 - 760 = -$250

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