1

Free Cash Flow

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

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

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

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

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

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 ValueEnterprise Value depends on Free Cash Flow

7

Enterprise Value

1 %)1(tt

t

WACC

FCFEV

EV = Market Value of the Capital investment

WACC% = Weighted Average Cost of Capital

8