Question

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

Answer #1

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: Depreciation = $ 800

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)**

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