Question

Suppose you are estimating a growth rate of FCF within the corporate value model. You noticed that the firms FCF has been declining in the past three years while its NOPAT and operating capital have been steadily increasing over the same time period. 1) What could be the reason for the decline in FCFs, and 2) what can you say, in general, about the future FCF growth rate?

Answer 1

Solution:

Free cash flow formula is

1.

FCF = NOPAT + Depreciation - Change in working capital - Capex

Since NOPAT is increasing, if all the components remain the same then FCF should increase but here FCF is decreasing that means that either Capex has increased or depreciation has decreased.

If Capex is increased then it means that the depreciation should increase but amount of Capex will be higher than the depreciation amount.

Hence the reason for decreasing FCF could be the increase in Capex.

2.

Future FCF growth should increase as Capex can not be increasing forever and this investment in Capex will also increase the sales growth and operating profit.