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What is the free cash flow to the firm under Choice #3 above? D. What is the free cash flow to the firm under Choice #2 above? C. What is the free cash flow to the firm under Choice #1 above? B. The total cash flow of the firm differs for the four choices. Note: The practice problem gives the operating cash flow = 300, but the operating cash flow differs for the four choices. Choices #2, #3, and #4 are optional under IFRS: interest paid is an operating or a financing cash flow interest and dividends received are operating or investing cash flows and shareholder dividends paid are an operating or financing cash flow.

Shareholder dividends paid = 25 We consider four choices for the classification of cash flows: Interest Paid Interest & Dividends Received Shareholder Dividends Paid #1 operating cash flow operating cash flow financing cash flow #2 financing cash flow operating cash flow financing cash flow #3 operating cash flow investing cash flow financing cash flow #4 operating cash flow operating cash flow operating cash flow Choice #1 is required by GAAP: interest paid is an operating cash flow interest and dividends received are operating cash flows and shareholder dividends paid are a financing cash flow.

Net investments in fixed capital = 200.

Operating cash flow (for the choice below) = 300.

Part B: The free cash flow to equity = cash flow from operations – fixed capital investments + net borrowing (or – net debt repayment) = 330 – 120 + (70 – 60) = 220 Exercise 6.2: Free cash flow to the firm A firm has the following figures for 20X2: Question: Why don’t we subtract the shareholder dividends of 50? Answer: Shareholder dividends are part of the free cash flow to the firm. Question: Why don’t we subtract the working capital expenditures of 44? Answer: The working capital expenditures were already subtracted from net income to derive the operating cash flow. Question: Why don’t we add the non-cash charges of 25? Answer: The non-cash charges were already added to net income to derive the operating cash flow. What is the free cash flow to equity? Part A: The free cash flow to the firm = cash flow from operations + interest paid × (1 – the tax rate) – fixed capital investments = 330 + 40 × (1 – 20%) – 120 = 242. What is the free cash flow to the firm? B.

Non-cash charges (depreciation and amortization) = 25.

FREE CASH FLOW TO EQUITY PDF

The capital expenditures amount comes from information within the investing activities section of the statement of cash flows.FA Module 6: Free cash flow – practice problems (The attached PDF file has better formatting.) Exercise 6.1: Free cash flow to the firm and to equity A firm has the following figures for its GAAP financial statements:

The cash provided by operating activities comes from the bottom of the operating activities section of the statement of cash flows. The free cash flow formula is as follows:įree cash flow = Cash provided by operating activities − Capital expenditures The idea is that companies must continue to invest in fixed assets to remain competitive.įree cash flow provides information regarding how much cash generated from daily operations is left over after investing in fixed assets. Back to: BUSINESS & PERSONAL FINANCE How Does Free Cash Flow Work?įree cash flow is cash provided by operating activities minus capital expenditures. These free cash flow are balanced for interest payments and loans. It ascertains profits excluding the non-cash or non-liquid expenses recorded in the income statement, and includes expenses related to equipment and assets, and variations in working capital.įree cash flow also does not include interest payments.įor ascertaining the estimated performance of a company regarding various capital structures, investment bankers and financial analysts use different types of free cash flow - such as free cash flow for the firm and free cash flow to equity.

FREE CASH FLOW TO EQUITY UPDATE

Update Table of Contents What is Free Cash Flow? How Does Free Cash Flow Work? What is Free Cash Flow?įree cash flow refers to the cash that a firm has post its cash outflow transactions which it uses for carrying its business activities and sustaining its long-term assets.įree cash flow is not the same as earnings or net income.