1 Operating cash flows OCF 2 Capital Expenditures CAPX 3 Increases in Net

# 1 operating cash flows ocf 2 capital expenditures

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1) Operating cash flows (OCF) 2) Capital Expenditures (CAPX) 3) Increases in Net Working Capital (∆NWC) note: increases will be + if NWC decreases then negative and will subtract a negative below, or add change in NWC FCF is : FCF = OCF – CAPX – ∆NWC Free Cash Flows.
16 1 (a) Operating cash flows (OCF) = EBIT x (1 - Tax Rate) + Depreciation. The operating cash flows generated by just the assets (no effect of interest or tax shield from interest) EBIT = Earnings Before Interest & Taxes = Sales – Costs - Depreciation . Why add back depreciation? Depreciation reduced EBIT but was not a cash expense. Only the tax savings of depreciation is a cash flow. 1 (b) Alternatively, where EBITDA = EBIT + Depreciation OCF = EBITDA*(1-Tax Rate) + (Tax Rate)*Depreciation. Same OCF either way you calculate it Free Cash Flows: 4 steps Value of the depreciation tax shield
17 Example 1: Omega Inc. has sales (revenue) of \$100,000; operating costs (expenses not including depreciation) of \$30,000; and depreciation expense of \$10,000. The tax rate is 30%. What is the OCF? OCF = (100,000 – 30,000 – 10,000) x (1 - .3) + 10,000 = \$52,000 OR OCF = (100,000-30,000) x (1 - .3) + 10,000 x .3 = \$52,000 Free Cash Flows: 4 steps EBIT (1 – t)= EBIT – EBIT * t= EBIT – tax on EBIT
18 2. Compute Capital Expenditures (CAPX) Purchase of new equipment – e.g., lab equipment, buildings. Positive CAPX (buying something) is a cash outflow, negative CAPX (selling something) is a cash inflow. CAPX is either given (on the statement of cash flows) or we can infer this cash flow from firm balance sheets. Balance sheet reflect this as Fixed Assets or Property, Plant and Equipment (PPE) Net Fixed Assets = Gross Fixed Assets – Accumulated Depreciation Interested in the change in Gross Fixed assets : Increase is a cash outflow; decrease is a cash inflow Often only Net Fixed Assets (NFA) is available CAPX = Change in NFA + Depreciation Expense Note we add back depreciation to adjust for how depreciation is accounted for in Net PPE. Free Cash Flows: 4 steps
19 3. Compute Change in Net Working Capital (∆NWC) Recall Net Working Capital = Current Asset – Current Liabilities Changes in NWC affect cash flows because they need to be financed with cash. It is the change in short-term accounts. An increase in NWC is a cash outflow (you bought something, on net), while a decrease in NWC is a cash inflow (you sold something, on net). Only consider non-financing NWC. This means that we will ignore (excess) cash and ignore debt payments. Note: if change in cash is stated as used for operations (not excess) we would include that. Free Cash Flows: 4 steps
20 Example 1. When a new project is undertaken it may take a while for customers to pay new sales, i.e. accounts receivable will increase. You recorded the sales and thus sales revenue and OCF record this as an inflow.

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