Joe Inc. recently reported operating income of $3.50 million (EBIT), depreciatio

Question

Joe Inc. recently reported operating income of $3.50 million (EBIT), depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net working capital totaled $1.10 million. How much was its free cash flow, in millions? Show all work. Joe Inc. recently reported operating income of $3.50 million (EBIT), depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net working capital totaled $1.10 million. How much was its free cash flow, in millions? Show all work.

Explanation / Answer

Free Cash Flow (FCF) is an important measure of a company's financial performance. It indicates the cash that the company generates for a specified period after incurring capital expenditure and maintaining it's working capital requirement.  

The Free Cash Flow (FCF) may be computed as follows:

EBIT ( 1 - Tax Rate) + Depreciation (and/or Amortization) - Capital Expenditure - Change in Net Working Capital

where,

EBIT denotes the Earnings before Interest and Tax (after deducting Depreciation). We use the EBIT since we are calculating the FCF on a firm wide level.

The FCF for Joe Inc. may be calculated as follows (all figures in millions):

$3.50 (1 - 0.4) + $1.20 - $1.10 = $2.20 million

Conclusion - Joe Inc. has a free cash flow of $2.20 million.  

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