Financial Management
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FIN443FreeCashFlowLecturenotes.docxLecture notes 4: Free Cash Flow (FCF)
FCF is cash that a firm can use to: 1) finance expansion, 2) reduce debt, 3) pay dividends, and 4) any combination of the previously mentioned uses. As your textbook indicates, FCF can also be used to determine the value of a firm’s operations and the estimated value of its stock.
Below are several formulas that can be used to determine FCF in 2019:
FCF19 = NOPAT19 – (TOC19 - TOC18) (1)
Where:
NOPAT19 = Net operating profit after tax in 2019
TOC19 = Total operating capital in 2019
TOC18 = Total operating capital in 2018
Also:
NOPAT = EARNINGS BEFORE INTEREST AND TAXES IN 2019 (EBIT19) * (1- TAX RATE IN 2019)
TOC19= NET OPERATING WORKING CAPITAL (NOWC19) +NET FIXED ASSETS (NFA19)
TOC18= NET OPERATING WORKING CAPITAL (NOWC18) +NET FIXED ASSETS (NFA18)
Note: Sometimes on the balance sheet the net plant, property and equipment is provided and it is the same as NFA.
Therefore equation 1 above can be written as:
FCF19= [EBIT19* (1-TAX RATE19)] - [(NOWC19+NFA19) - (NOWC18+NFA18)] (2)
Where:
NOWC19 = Operating current assets in 2019 (OCA19) – operating current liabilities in 2019 (OCL19)
NOWC18 = Operating current assets in 2018 (OCA18) – operating current liabilities in 2018 (OCL18)
Therefore equation 2 above can be written as:
FCF19= [EBIT19* (1-TAX RATE19)] - {[(OCA19- OCL19) +NFA19)] - [(OCA18- OCL18) +NFA18)]} 3
Where:
OCA19 = Current Assets in 2019 (CA19) - Marketable securities in 2019(MS19)
OCL19 = Current Liabilities in 2019- Current liabilities that are notes payable, mortgage payable and bonds payable in 2019)
OCA18 = Current Assets in 2018 (CA18) - Marketable securities in 2018(MS18)
OCL18 = Current Liabilities in 2018- Current liabilities that are notes payable, mortgage payable and/or bonds payable in 2019)
NOTE: OCA DOES NOT STAND FOR OTHER CURRENT ASSETS AND OCL DOES NOT STAND FOR OTHER CURRENT LIABILITIES.
NOTE: WHEN CALCULATING NOWC, EXCLUDE CURRENT ASSETS AND CURRENT LIABILITIES THAT ARE ASSOCIATED WITH RECEIVING OR PAYING DIVIDENDS AND/OR INTEREST. IF A FIRM DOES NOT HAVE ANY MARKETABLE SECURITIES THAT ARE CURRENT ASSETS, OPERATING CURRENT ASSETS AND CURRENT ASSETS ARE ONE AND THE SAME. CONSEQUENTLY, FOLLOWING THE SAME LOGIC, IT IS POSSIBLE (BUT NOT LIKELY) THAT OPERATING CURRENT LIABILITIES AND CURRENT LIABILITIES TO ALSO BE ONE AND THE SAME.
