Free cash flow

Just as NOPLAT identifies the profit for all investors, which includes all equity owners and all debt holders, free cash flow essentially does the same. FCF is the after-tax amount of cash flow, taking into account 

Unlike the cash flow from operations on an accountant s statement of cash flows that is found in an annual report, free cash flow is independent of financing and nonoperating items. If a company reports a significant gain or loss that is not directly related to the company s normal core business, such as a one-time gain on the sale of equipment, this amount should be excluded from the free cash flow calculation for an accurate picture of the company s normal cashgenerating ability. Thus, FCF depends on sales revenue, operating costs and taxes, and required investments in operations. 

As a reminder, FCF is the amount of cash flow a company generates after taking into account capital expenditures such as building or equipment. Since companies have some leeway about what is considered a capital expenditure, FCF can be affected. 

FCF = (Operating profit x [1 - Tax rate] + Depreciation) - Capital expenditure - Change in net operating working capital 

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They also manage projects for market value added (MVA). The free cash flow model provides the firm value ... 

The minimum interest rate that an investor should require is the yield available in the marketplace on a default-free cash flow. For bonds whose cash flows are denominated in euros, yields on European government securities serve as benchmarks for default-free interest rates. In some European countries, the swap curve serves as a benchmark for pricing spread product (e.g., corporate bonds). For now, we can think of the minimum interest rate that investors require as the yield on a comparable maturity benchmark security. 

For the model of industrial corporations, the optimum discriminant function consists of the following four financial ratios free cash flow to total debt (FCF/TD), inverse variation coefficient of operating cash flows (VACO), retained earnings to total assets (RE/TA), and total market value of the corporation (TMVD). An explanation of the financial ratios is given in the case study. The discriminant function is formulated as follows ... 

Free cash flow shows the residual payment flows available for debt redemptions. In the business year of 2000, this figure amounted to 2,384 million for Swissair. The book value of total debt is taken from the balance sheet and amounts to 18,863 million. FCF/TD is computed by dividing FCF by TD ... 

Fixed capitai investment After-tax free cash flow... 

Table 5.3 provides an example of how free cash flow is found. Free cash flow is 2,100M and cash flow available to investors is 2,276M. 

Table 5.3 Abbreviated Cash Flow Statement and Free Cash Flow...

Decrease (increase) in equity investments 150 Free cash flow 2,100... 

Just as free cash flow is important to company valuation (Chapter 5), it is also important when evaluating projects. Relevant cash flows are used to evaluate projects. Relevant cash flows are the additional cash outflows and inflows that a company ej eriences if the project is undertaken. 

As a reminder from Chapter 5 to calculate free cash flow, operating income (profit) is adjusted for taxes, depreciation, capital expenditures, and any change in working capital. 

Nevertheless, nowadays the maximization of the shareholder s value (SHV) seems to be the main priority of the firms and what really drives their decisions. The use of SHV as the objective to be maximized is mainly motivated by the fact that it reflects in a rather accurate way the capacity that the company has to create value. The SHV of the firm can bee indeed improved by maximizing its CV. According to Weissenrieder (1998), the market value of a company is a function of four factors (i) investment, (ii) cash flows, (iii) economic life, and (iv) capital cost. Specifically, this model applies the discounted-free-cash-flow method (DFCF) to compute the CV of a company. 

The Discounted-Free-Cash-Flow Method (DFCF)... 

The framework suggested in this book is thus in consonance with the new trends in PSE, which are going toward an enterprise wide optimization framework that aims to integrate all the functional decisions into a global model that should optimize an overall key performance measure. Here, it is proposed the corporate value measured through the discounted free cash flow method as a suitable first approach to this posed requirement. 

Quarter Profit after sales A Accounts receivable A Accounts payable Net investment Other expenses Change in invested capital Discounted free cash flows... 

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