Question

Why do we solve for free cash?  In your answer, put emphasis on tools that we've already learned so far this term. In other words, what is the endgame?  Next, please write out the FCF formula.  After you've written out the equation, please explain the meaning of each variable

Answer 1

Free cash flow refers to cash remaining after keeping aside for fixed assets and working capital needs. This represents the excess cash available with a company after its fixed and working capital needs have been met. We compute FCF for project analysis as well as capital budgeting analysis where projects are evaluated on the basis of FCF that it would generate.

FCF = Cash from operations- Capital expenditure

= Net Income + Non cash expenses - Increase in NWC - capital expenditure

Net Income refers to Income after taxes.

Non cash expenses refer to expenses such as depreciation which do not involve any cash flow. Increase in NWC refers to increase in working capital of the business. Working capital = Current assets- Current liabilities

Capital expense = Expenditure on fixed assets such as plant and machinery, furniture, etc.