![]() ![]() In our pro-forma, F ive-year income statement, we have many of the elements: EBIT, depreciation, and tax rate (i.e., 40%). In order to do this, we need to recall the FCF formula. Here, once again, it is: Multiply by (1 Tax Rate) to get the company’s Net Operating Profit After Taxes, or NOPAT. In this connection, take note that interest, for example, is excluded from FCF because it is a capital cost, as discussed earlier. Each company is a bit different, but a formula for Unlevered Free Cash Flow would look like this: Start with Operating Income (EBIT) on the company’s Income Statement. This spreadsheet will be useful when, later, we assess such cash flows in present value terms in order to make capital investment decisions. The figures for EBIT and Depreciation were calculated and the solutions can be found in Section #8.6 these figures are needed for the FCF problem herewith. Now, we will conduct an exercise, based on the earlier net income and EPS projections, in which we shall create a pro-forma statement – of a sort – of free cash flows for multiple future years rather than just one year’s net income. ![]() We also understand the implications of depreciation, a non-cash expense, on income and cash. FCFF NI + D&A +INT (1 TAX RATE) CAPEX Net WC. We have already projected net income and earnings per share ( see above under the heading “ Corporate Forecasting and Strategic Planning ”). Here are some other equivalent formulas that can be used to calculate the FCFF. This example is generic in the sense that it may represent either the view of an external analyst looking at a corporation’s most recent financial report, and, based on the report, making an assessment of the corporation’s growth prospects and equity investment merits based on its FCF or it could be a projection that an internal analyst makes for a potential corporate investment project. Projections “under uncertainty” are beyond this manual’s scope. In reality, projections are virtually always going to be somewhat incorrect – when all is said and done. This discussion has, so far, assumed that we, financial analysts, are perfectly capable of making accurate, numerical projections about matters that have not yet occurred. The firm will (should) choose investments that further maximize FCF. To summarize, free cash flow may be thought of as the firm’s after-tax cash flows less any spending on either the maintenance or replacement of fixed assets, and in acquiring working capital. The free cash flow left over may be used either to pay down debt, pay dividends, buy back stock, for discretionary growth investments and more. The net use of funds was therefore $2 million, which accordingly reduces free cash flow. Alternatively, one might say that c urrent assets increased by $1 million, a use of funds current liabilities decreased by $ 1 million, also a use of funds. ![]() Working Capital next year versus this year increased by $2 million : (6-2) – (5-3). Note that the definition of these numbers will be documented in the loan agreement, so it can depend on negotiations, and there isn’t a formal definition, just industry norms.(Calculation) = $70 + $0.30 – $7 – $2 = $61.3 million In this calculation, they might also deduct dividends if they are planned to be made and the company is publicly traded, so cutting dividends would limit the business’s ability to raise equity capital in the future. In other cases, analysts will calculate a number called CFADS or Cash Flow Available for Debt Servicing. Levered free cash flow is only available to equity holders, so discounting it, like a net income multiple, will give you an equity value.Ĭonfusingly there are variants to the above calculations, for example in some models analysts will use leveraged free cash flows as only excluding interest rather than debt repayments so they can use the number to estimate the cash available for debt repayment only. You could value a firm using levered free cash flows by discounting them by the cost of equity rather than the Weighted Average Cost of Capital. Sometimes people call levered free cash flows, ‘cash flows available to equity holders’. In comparison levered free cash flows measure the amount of cash the business generates to pay dividends – after all payments to debt holders. When we calculate free cash flows we restate the cash flow statement only including items the business needs to operate:
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