Question

3-17 FREE CASH FLOW Financial information for Powell Panther Corporation is shown here. Powell Panther Corporation: Income Statements for Year Ending December 31 (Millions of Dollars) 2018 2017 Sales $ 1,200.0 $1,000,0 Operating costs excluding depreciation and amortization 1,020.0 850.0 EBITDA $ 180.0 $ 150.0 Depreciation and amortization 30.0 25.0 Earnings before interest and taxes (EBIT) $ 150.0 $ 125,0 Interest 21.7 20.2 Earnings before taxes (EBT) $ 1283 $ 104.8 Taxes (40%) 51.3 41.9 Net income $ 77.0 $ 62.9 Common dividends $ 60.5 $ 46.4 Powell Panther Corporation: Balance Sheets as of December 31 (Milions of dollars) 2018 2017 Assets Cash and equivalents $ 12.0 $ 10.0 Accounts receivable 180.0 150,0 Inventories 180.0 200.0 Total current assets $ 3720 5360.0 Net plant and equipment 300.0 250,0 Total assets $ 672.0 $610,0 Liabilities and Equity Accounts payable $108.0 $ 90.0 Accruals 72.0 60.0 Notes payable 67.0 51.5 Total current liabilities $247.0 $201.5 Long-term bonds 150.0 150.0 Total liabilities $3970 $ 351.5 Common stock (50 million shares) 50.0 50.0 Retained earnings 225.0 208.5 Common equity $275.0 $ 258.5 Total liabilities and equity $672.0 $ 610.0 a. What was net operating working capital for 2017 and 2018? Assume the firm has no excess cash. b. What was the 2018 free cash flow? c. How would you explain the large increase in 2018 dividends?

Answer 1

Solution

a.Calculation of Net operating working capital for 2017 & 2018

Net Operating Working Capital (NOWC) = Net Operating Assets-Net Operating Liabilities

NOWC = Cash + Accounts Receivable + Inventories - Accounts Payable - Accrued Expenses

NOWC for 2017 = ($10 + $150 + $200 - $90 - $60) in million dollars

NOWC for 2017 = $210 in million dollars

Applying same formula for NOWC 2018, it gives -

NOWC for 2018 = ($12+ $180 + $180 - $108 - $72) in million dollars

NOWC for 2018 = $192 in million dollars

b. Free Cash Flow (FCF) = EBIT(1-Tax Rate) + Depreciation &Amortization +/- Change in Net Working Capital - Capital Expenditure

FCF for 2018 = 150 (1-0.4) + $30 +$18 ($210-$192)-$50 ($250-$300)

FCF for 2018 = $88 in million dollars

c. Increase in dividends in majorly caused primarily by 2 reasons:

1. Increase in net income of the company,

2. A shift in the company’s growth strategy that leads the company to decide to expend less of its earnings in seeking growth and expansion, thus leaving a larger share of profits available to be returned to equity investors in the form of dividends