Homework Answers
Ans:
Free Cash Flow of a firm = NOPAT - Net Investments
Computation of NOPAT:
Net operating profit after tax (NOPAT) = EBIT * (1 - tax rate)
Where
Tax rate as given 34% i.e 0.34
Earnings before interest and tax (EBIT) can be computed as follows
| Sales (as given) | 1200 | |
| Less | Cost of Goods sold (as given) | 400 |
| Less | Depreciation (as given) | 100 |
| EBIT | 700 |
Hence
Net operating profit after tax (NOPAT) = 700 * (1 - 0.34) = $462
Computation of Net Investments:
Net Investments = Capital Spending during the year + Net changes in working capital - Depreciation
Where
Capital spending can be computed as follows
| The closing value of fixed assets (in the year 2003) | 6100 | |
| Add | Depreciation provided during the year | 100 |
| Less | Opening value of the fixed asset (in the year 2002) | 6000 |
| Capital spending | 200 |
Net change in working capital = Working capital of the previous year - Working capital of the current year
Where
working capital = Current assets - Current liabilities
As given in the question
| 2002 | 2003 | |
| Current Assets: | ||
| Cash | 800 | 500 |
| Marketable securities | 400 | 300 |
| Accounts receivable | 900 | 800 |
| Inventory | 1800 | 2000 |
| Total (A) | 3900 | 3600 |
| Current Liabilities: | ||
| Notes Payable | 1200 | 1600 |
| Accounts Payable | 2400 | 2000 |
| Total (B) | 3600 | 3600 |
| Working Capital (A-B) | 300 | 0 |
Hence
The net change in Working Capital = 300 - 0 = 300
Hence
Net investments would be
| Capital spending | 200 | |
| Add | Net Change in Working capital | 300 |
| Less | Depreciation | 100 |
| Net Investment | 400 |
Free Cash Flow of a firm
Hence free cash flow can be computed now as follows
| NOPAT | $462 | |
| Less | Net Investments | $400 |
| Free Cashflow | $62 |
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