Question

# Watson Oil recently reported (in millions) \$8,250 of sales, \$5,750 of operating costs other than depreciation,...

Watson Oil recently reported (in millions) \$8,250 of sales, \$5,750 of operating costs other than depreciation, and \$800 of depreciation. The company had \$3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to make \$1,250 of capital expenditures on new fixed assets and to invest \$300 in net operating working capital. By how much did the firm's net income exceed its free cash flow? Do not round the intermediate calculations. a. \$601 b. \$646 c. \$717 d. \$633 e. \$808

Sales = \$ 8250

Less: Operating Costs = \$ 5750

EBITDA = \$ 2500

Less: Depreciation = \$ 800

EBIT = \$ 1700

Less: Interest Expense = Interest Rate x Outstanding Bonds = 0.05 x 3200 = \$ 160

EBT = \$ 2340

LessL Tax @ 35% = 0.35 x 2340 = \$ 819

Net Income = \$ 1521

Add: After-Tax Interest Expense = (1-0.35) x 160 = \$ 104

Less: Investment in Fixed Assets = \$ 1250

Less: Net Operating Working Capital = \$ 300

Free Cash Flow to Firm (FCFF) = \$ 875

Difference between Net Income and Free Cash Flow = 1521 - 875 = \$ 646

Hence, the correct option is (b)

Hence, the correct option is (e)