1 operating cash flows ocf 2 capital expenditures

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.