Calculate The Firm’s Free Cash Flow (FCF) For The Year-End

Calculate the firms free cash flow FCF for the year ended December 31 2015 using Equation 4 4

Calculate the firm’s free cash flow ( FCF ) for the year ended December 31, 2015, using Equation 4.4

Consider the following balance sheets and selected data from the income statement of Keith Corporation. Keith Corporation Balance Sheets December 31 Assets Cash $1,500 $1,000 Marketable securities 1,800 1,200 Accounts receivable 2,000 1,800 Inventories 2,900 2,800 Total current assets $8,200 $6,800 Gross fixed assets $29,500 $28,100 Less: Accumulated depreciation 14,100 Net fixed assets $14,800 $15,000 Total assets $23,000 $21,800 Liabilities and stockholders’ equity Accounts payable $1,600 $1,500 Notes payable 2,800 2,200 Accruals Total current liabilities $4,600 $4,000 Long-term debt 5,000 5,000 Total liabilities $9,600 $9,000 Common stock $10,000 $10,000 Retained earnings 3,400 2,800 Total stockholders’ equity $13,400 $12,800 Total liabilities and stockholders’ equity $23,000 $21,800 Keith Corporation Income Statement Data (2015) Depreciation expense $1,600 Earnings before interest and taxes (EBIT) 2,700 Interest expense 367 Net profits after taxes 1,400 Tax rate 40%

Paper For Above instruction

Free cash flow (FCF) is an essential financial metric used to assess the amount of cash a company generates after accounting for capital expenditures necessary to maintain or expand its asset base. It provides insight into the company's ability to generate cash that can be used for dividends, stock repurchases, debt repayment, and reinvestment. Calculating FCF accurately involves analyzing various financial components, including operating cash flows, capital expenditures, and changes in net working capital. For Keith Corporation, we employ Equation 4.4, which defines free cash flow as:

FCF = Operating Cash Flow (OCF) - Capital Expenditures (CapEx) - Changes in Net Working Capital

Calculation of Operating Cash Flow (OCF)

Operating cash flow represents the cash generated from a company's core business activities. It can be derived from net income by adjusting for non-cash expenses such as depreciation and changes in working capital. Using Equation 4.3, OCF is calculated as:

Operating Cash Flow = EBIT + Depreciation - Taxes

From the provided data:

  • EBIT = 2,700
  • Depreciation expense = 1,600
  • Tax rate = 40%

Taxes are calculated on earnings before interest and taxes (EBIT) as follows:

Tax = EBIT x Tax rate = 2,700 x 0.40 = 1,080

Therefore, operating cash flow is:

OCF = 2,700 + 1,600 - 1,080 = 3,220

Calculation of Capital Expenditures (CapEx)

Capital expenditures refer to investments in property, plant, and equipment to maintain or increase productive capacity. CapEx is calculated by examining changes in gross fixed assets, adjusted for depreciation:

CapEx = Ending Net Fixed Assets - Beginning Net Fixed Assets + Depreciation

From the data:

  • Ending Net Fixed Assets = 14,800
  • Beginning Net Fixed Assets = 15,000
  • Depreciation expense = 1,600

Calculating CapEx:

CapEx = 14,800 - 15,000 + 1,600 = 3,400

Calculation of Changes in Net Working Capital (NWC)

Net working capital changes reflect the difference in current assets and current liabilities between two periods. It measures the additional cash tied up in short-term assets and liabilities required to support ongoing operations.

Beginning NWC = Current Assets - Current Liabilities at the start of the period

Ending NWC = 8,200 - 4,600 = 3,600

Initial NWC (from previous year's data) = 6,800 - 4,000 = 2,800

Change in NWC = Ending NWC - Beginning NWC = 3,600 - 2,800 = 800

Calculating Free Cash Flow (FCF)

Now, assembling all components:

  • Operating Cash Flow (OCF) = 3,220
  • Capital Expenditures (CapEx) = 3,400
  • Change in Net Working Capital = 800

Applying the FCF formula:

FCF = 3,220 - 3,400 - 800 = -980

The negative free cash flow indicates that Keith Corporation spent more cash on capital investments and working capital increases than it generated from core operations during 2015. This scenario could suggest significant reinvestment for future growth, or it might highlight operational or financial challenges that the company faces in generating cash.

Conclusion

The calculation of free cash flow provides a clear view of Keith Corporation's cash position after meeting its operational and capital needs. The negative FCF suggests strategic reinvestment, which, if successful, can lead to substantial future growth. However, it also emphasizes the importance of monitoring operational efficiency and capital management to ensure sustainable value creation for shareholders.

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