Question

Accounting statements represent a company’s earnings, but this is not the real cash that a company generates. Earnings data can be manipulated and can be deceiving. Thus, corporate decision makers and security analysts focus on the free cash flow that a firm generates to analyze the company’s real cash position.

Which of the following statements best describes free cash flow?

(A) The amount of a firm’s available cash that can be used without harming operations or the ability to produce future cash flows
(B) The amount of a firm’s available cash used to write off capital expenditures and depreciation

Answer 1

Answer:

A) The amount of a firm’s available cash that can be used without harming operations or the ability to produce future cash flows

Explanation:

The formula to compute the free cash flow is shown below:

= EBIT × (1 -Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - net capital Expenditure.

where,

EBIT = Earning before interest and tax

The free cash flow is the cash that is left after paying off the capital expenditure, and other operation expenses