Question

Last year Firm X had sales of $100,000, labor costs of $30,000, material costs of $30,000, and depreciation of $10,000. Assume that labor and material costs were paid in cash. The tax rate on its net income was 40%. Assume that the firm made no capital expenditures and had no changes in net operating working capital during the year. What was Firm X's free cash flow?

Answer 1

Firm X's free cash flow is calculated by subtracting labor, materials, and depreciation from sales, and then subtracting taxes from the subtotal. With no capital expenditures or changes in net operating working capital, the firm's free cash flow is the after-tax net income plus depreciation, totaling $28,000.

Step-by-step explanation:

To calculate Firm X's free cash flow, we start by determining its net income, which is calculated by subtracting labor costs, material costs, and depreciation from its sales revenue. Firm X's sales revenue was $100,000, labor costs were $30,000, material costs were $30,000, and depreciation was $10,000. The firm's net income before taxes would be $100,000 - $30,000 - $30,000 - $10,000 = $30,000. With a tax rate of 40%, the taxes paid would be $30,000 * 0.4 = $12,000. Thus, the net income after taxes would be $30,000 - $12,000 = $18,000.

Free cash flow is the cash that a company generates from its normal business operations after subtracting any capital spending and changes in net operating working capital. However, the question states that there were no capital expenditures and no changes in net operating working capital. So, free cash flow is simply the net income after taxes plus depreciation (a non-cash expense). Therefore, Firm X's free cash flow is $18,000 + $10,000 = $28,000.