Question

• Your existing business generates $123,000 in EBIT.

• The corporate tax rate applicable to your business is 25%.
• The depreciation expense reported in the financial statements is $23,429.
• You don't need to spend any money for new equipment in your existing cafés; however, you do need $18,450 of additional cash.
• You also need to purchase $9,840 in additional supplies--such as tableclothes and napkins, and more formal tableware-on credit . It is also estimated that your accruals, including taxes and wages payable, will increase by $6,150.
Based on your evaluation you have____ in free cash flow. Can a company have negative free cash flow?
A) NO
B) Yes

Answer 1

To calculate free cash flow, start with EBIT, subtract taxes, add back depreciation, and subtract the increase in working capital to get the free cash flow. The company has $80,239 in free cash flow. Yes, a company can have negative free cash flow if expenses exceed revenues and non-cash items.

Step-by-step explanation:

To calculate free cash flow, we need to start with EBIT (Earnings Before Interest and Taxes) which is $123,000.

Next, we subtract the taxes, which is calculated by multiplying the EBIT by the tax rate of 25%, giving us $30,750.

We then add back depreciation expense of $23,429 to account for the non-cash expense.

Finally, we subtract the increase in working capital, which is the additional cash needed of $18,450, the additional supplies on credit of $9,840, and the increase in accruals of $6,150, giving us a total of $34,440.

Therefore, the free cash flow is calculated as:

$123,000 - $30,750 + $23,429 - $34,440 = $80,239.

Based on this evaluation, the company has $80,239 in free cash flow.

Yes, a company can have negative free cash flow. This would occur if the cash outflows (expenses) exceed the cash inflows (revenues and non-cash items). Negative free cash flow may indicate that the company is having financial difficulties and is not generating enough cash to cover its expenses.