Calculation of Free Cash Flow Al Imam Mohammad Ibn Saud Islamic University College of Economics and Administrative Sciences Department of Finance and Investment Level 4: All branches EXERCISE 1 Calculation of Free Cash Flow

Problem 1 Question1: You are given the following information about a corporation.. Statement income 2017 2018 Sales 250 300 Operating costs 180 200 Depreciations 45 50 Net Working Capital 20 25 Capital Spending If we assume the firm faces a 20% tax rate, calculate the free cash flow (FCF) for the year 2018.

Answer 1 Statement income 2017 2018 Sales 250 300 Operating costs 180 200 EBDIT   100 Depreciation 45 50 EBIT Taxes 10 NI 40 OCF 90 Net Working Capital 20 25 Changes in NWC 5 Capital Spending FCF 35

Answer 1: FCF = OCF - ∆NWC - CS FCF = 90 - 5- 50 FCF = 35

Question 2: You are considering an investment in a new project. You anticipate additional earnings before depreciation, interest and taxes (EBDIT) of $100,000 for the first year of operation of the project in 2018, and, over the next five years, the firm estimates that this amount will grow at a rate of 5% per year. The project will require an initial investment of $400,000 that will be depreciated over a five-year period towards a zero salvage value using straight-line depreciation. You estimate that this new project will need net working capital equals to $20,000 at the start of the project and after that it will be calculated on the basis of 20% of EBDIT each year. Cash requirements of net working capital are retrieved at the end of the project (at the end of the fifth year).

Question 2: If we assume the firm faces a 30% tax rate, calculate the project’s annual free cash flow (FCF) for each of the next five years.  

Answers 2: Note: To solve these questions you can use a table and doing the following formulae: Earnings Before Depreciation, Interests and Taxes EBDIT: EBDIT = Sales Revenues - Operating Costs Earnings Before ,Interests and Taxes EBIT: EBIT = EBDIT - Depreciation Net Income NI: NI = EBIT - Taxes Operating Cash Flow OCF: OCF = EBDIT– Taxes Changes in Net Working Capital Free Cash Flow ΔNWC = NWCt+1 - NWCt FCF = OCF - ΔNWC - Capital Spending

Answer 2: Year 1 2 3 4 5 EBDIT   100000 105000 110250 115762.500 121550.625 Depreciation 80000 EBIT 20000 25000 30250 35762.500 41550.625 Taxes 6000 7500 9075 10728.75 12465.188 NI 14000 17500 21175 25033.750 29085.438 OCF 94000 97500 101175 105033.750 109085.438 NWC 21000 22050 23152.5 24310.12 changes in NWC - 1000 1050 1102.5 capital spending 400000 FCF -420000 96500 100125 103931.25 109085.44