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1 Free Cash Flow

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2 Free Cash Flow (FCF) FCF is the amount of cash available to make payments to both Debt and Equity investors: Payments to creditors (debt investors): 1) interest expense 2) principal payments Payments to stockholders: 1) dividends 2) stock repurchases

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Free Cash Flow Current Assets - Oper. Current Liab. PP&E Debt (L.T. + S.T.) Equity = Invested Capital + NOPAT + Depreciation - Reinvest in NWC - Capital Expenditures on PP&E =Free Cash Flow = Capital investment generates Principal + Interest Dividends + Stock Repurchase Net Working Capital 3

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Free Cash Flow Formula + NOPAT + Depreciation (add back any non-cash) - Change in NWC (reinvest in top of box) - Capital expenditures (reinvest in PP&E) Some of NOPAT is typically reinvested in the business for growth and maintenance needs The amount of cash remaining after reinvestment is Free Cash Flow, or freely available to payout to investors 4

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Free Cash Flow to Debt The amount of FCF paid out to Debt is = Interest Expense A.T. minus the change in Debt Interest Expense x (1-t) - Debt Notice if this change in Debt is negative, then we repaid some debt, and this is the same as saying Interest Expense plus Debt principal repaid (as on the FCF diagram earlier) If the change in Debt is positive, then we borrowed this change from the creditors, reducing their net cash flow Note that back in our FCF diagram the arrow representing cash flow can go both directions, either toward or away from the investor 5

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Free Cash Flow to Equity The amount of FCF paid out to Stockholders is = Dividends minus the change in Common Stock Dividends - Common Stock Notice if this change in Stock is negative, then we repurchased some stock from our stockholders, and this is the same as saying Dividends plus Stock Repurchases (as on the FCF diagram earlier) If the change in Stock is positive, then we sold this amount of stock to investors, reducing their net cash flow 6

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Enterprise Value (EV) The market value of the total Capital investment, Debt plus Equity, is called Enterprise Value A primary goal of financial management is to enhance the Enterprise Value Enterprise Value depends on Free Cash Flow 7

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Enterprise Value EV = Market Value of the Capital investment WACC% = Weighted Average Cost of Capital 8

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DES Chapter 3 1 Financial Statements and Free Cash Flow.

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