Question

Waverley Inc. reported the following on its year-end financial statements: earnings before interest and taxes (EBIT) of $1,400,000, income tax expense of $280,000, depreciation expense of $260,000 and fixed asset purchases of $320,000. In addition, Waverley’s free cash flow was $845,000 and the company had no debt. What was its change in net operating working capital over the year?

a. Increase of $215,000
b. Decrease of $215,000
c. Decrease of $335,000
d. Increase of $335,000
e. More information is needed to answer the question

Answer 1

The change in net operating working capital for Waverley Inc. over the year was an increase of $215,000, which is calculated by adjusting the free cash flow with EBIT, tax rate, depreciation, and capital expenditures.

Step-by-step explanation:

The calculation for the change in net operating working capital (NOWC) starts with the understanding that Free Cash Flow (FCF) is calculated as follows:

FCF = EBIT(1-Tax rate) + Depreciation - Capital Expenditures - ∆NOWC

We are given that EBIT is $1,400,000, the tax rate is $280,000 / $1,400,000 = 20%, depreciation is $260,000, capital expenditures are $320,000, and free cash flow is $845,000.

Now solving for ∆NOWC:

FCF = $1,400,000(1-0.20) + $260,000 - $320,000 - ∆NOWC

$845,000 = $1,120,000 + $260,000 - $320,000 - ∆NOW

$845,000 = $1,060,000 - ∆NOWC

∆NOWC = $1,060,000 - $845,000

∆NOWC = $215,000

Therefore, the change in net operating working capital is an increase of $215,000.