Cellular Access, Inc. is a cellular telephone service provider that had an EBIT of $250 million for the most recent fiscal year. The firm had depreciation expenses of $100 million, capital expenditures of $200 million, and interest expenses of $40 million. Working capital increased by $10 million. The firm’s tax rate is 40%. Calculate the free cash flow for Cellular Access for the most recent fiscal year.
FCFF or free cash flow to the firm can be calculated using the following formula,
FCFF = EBIT( 1 - tax rate ) + Depreciation/Amortization - Fixed Capital Investment - Working Capital Investment
Fixed capital investment is capital expenditure for the period
Working capital investment is the increase in working capital as compared to the previous year
Working capital investment also refers to the additional working capital required this year as compared to previous year.
So, FCFF = 250 ( 1 - 0.4 ) + 100 - 200 - 10 = 40 million
In calculating working capital for free cash flow purposes, we exclude cash so any increase in current assets leading to a change in working capital means that more cash is tied up in the business thus increase in Working capital is deducted for FCFF calculation.
Investment in Fixed capital or Capital expenditure also means cash outflow from the business thus it reduces FCFF.
We add depreciation because it is a non cash expense.
The EBIT is turned into EBI as we need to take out the tax effect and leave interest in the firm as FCFF is for the whole firm, which is made up of Equity and debt providers both.
