Question

The CFO of Flychucker Corp. is thinking about what he learned in his Corporate Finance class...

The CFO of Flychucker Corp. is thinking about what he learned in his Corporate Finance class about Cash Flow from Assets or Free Cash Flow. He is sitting in his office and the date is February 26, 2018. He wants to estimate the Free Cash Flow for the business for 2018. He has the following information:

            Sales for 2017 were $30M and sales for 2018 are expected to be $40M.

            The operating margin on EBIT/Sales is expected to be 16%.

            The tax rate is 20%.

            Depreciation expense is 10 percent of sales.

            Dividends for the year will be $2M, paid out as a special one-time dividend.

            Principal payments on the bank loan are scheduled at $3M for the year.

            The Board has just approved a share repurchase program costing $10 million that

               will start in 2018.

            The company expects to borrow $5 million in 2018 to acquire new equipment

               costing $5 million.

            Net working capital for the company is typically 12 percent of sales.

            Interest expense for the year is estimated at $1 million.

            The CFO expects to be awarded stock options in 2018 having a cost of $1 million.

            Marketing expenses for the year are estimated at $1M.

Estimate Cash Flow from Assets or Free Cash Flow for Flychucker Corp. for 2018. Explain how the Total Value of the Firm is related to Expected Free Cash Flow.

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Answer #1
Amount $ Millions
Sales 40
EBIT 6.4
Intrerest 1
EBT 5.4
Tax@20% 1.08
EAT 4.32
Add: Depre 4
Less: Principal payment of loan 3
Less: Special Divident 2
Less: increase in NWC 1.2
Less: awarded stock options 1
Free Cash flow for 2018= 1.12

(1)    It is pessumed that Depreciation, Marketing Expenses are already deducted to arrive EBIT    (2)    The borrowal of $5 million in 2018 to acquire new equipment costing $5 million. Is does not affect the free    Cash flow. So it is ignored (3) Net working capital for the company is typically 12 percent of sales. The additional investment in NWC is    considered i.e. (40m x 12%) - (30m x 12%) = 1.2

Free cash flow model is one of the relevant method of valuation of firm. in this method of valuation the free cash flows are discounted for the given period of time. that is the rrelationship of free cashflow and value of firm

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