1. 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

2. 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.

3. 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

4. Answer 1:
FCF = OCF - ∆NWC - CS
FCF =
FCF = 35

5. 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).

6. 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.

7. 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

8. Answer 2:
Year 1 2 3 4 5
EBDIT
100000
105000
110250
Depreciation
80000
EBIT
20000
25000
30250
Taxes
6000
7500
9075 NI
14000
17500
21175
OCF
94000
97500
101175
NWC
21000
22050
changes in NWC -
1000
1050
1102.5
capital spending
400000
FCF
96500
100125