Which of the following statements best describes free cash flow? O Residual cash

Question

Which of the following statements best describes free cash flow? O Residual cash flow after taking into account operating cash flows, including fixed-asset acquisitions, asset sales, and working-capital expenditures O Cash flows generated by operating the business Suppose you are the only owner of a chain of coffee shops near universities. Your current cafes are doing well, but you are interested in starting a fine-dining restaurant. You decide to use the cash generated from your existing business to enter into a new business. Your accountant provides you with the following data on your current financial performance: Financial update as of June 15 Your existing business generates $87,000 in EBIT * The corporate tax rate applicable to your business is 35%. The depreciation expense reported in the financial statements is $16,571. You don't need to spend any money for new equipment in your existing cafes; however, you do need $13,050 of additional cash. napkins, and more formal tableware-on credit. by $4,350 . You also need to purchase $6,960 in additional supplies-such as cloth tableclothes and It is also estimated that your accruals, including taxes and wages payable, will increase in free cash flow. Free cash flow can be used for various reasons, including distributing it to stockholders and debtholders. Which of the

Explanation / Answer

(1) Free cash flow is the :

Residual cash flow after taking into account operating cash flows, including fixed assets aquisitions, asset sales and working capital expenditures.

Hence, correct option is (a)

Cash flows generated by operating the business refers to the cash flows from operations. Hence, it is not free cash flows but only a part of the free cash flows. Hence (b) is not the correct option.

(2)

Tax expense = 87,000 x 35%

= $30,450

Increase in current assets = Increase in cash + Increase in supplies

= 13,050 + 6,960

= $20,010

Increase in current liabilities = Increase in accounts payable + Outstanding expenses

= 6,960 + 4,350

= $11,310

Increase in working capital = Increase in current assets - Increase in current liabilities

= 20,010 - 11,310

= $8,700

Operating cash flows = EBIT + Depreciation - Tax - Increase in working capital

= 87,000 + 16,571 - 30,450 - 8,700

= $64,421

Free cash flows = Operating cash flows - Capital expenditures

= 64,421 - 0

= $64,421

Kindly give a positive rating if you are satisfied with the answer. Feel free to ask if you have any doubts. Thanks.

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