Final answer:
The correct calculation of Cactus' free cash flow is by using the formula Net Income + Depreciation - Capital Expenditures - Change in Working Capital, considering the net income already includes the effect of the 25% tax rate.
Step-by-step explanation:
The student is asking about the calculation of free cash flow for the fictional entity Cactus, given a tax rate of 25%. Among the options provided, the correct formula to calculate the free cash flow is option a. Net Income + Depreciation - Capital Expenditures - Change in Working Capital. This calculation begins with the company's net income, adds back non-cash charges like depreciation (since these do not represent actual cash outflows), and then subtracts capital expenditures which are the funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment. Finally, it also adjusts for the change in working capital, which measures the short-term liquidity of a company and represents a change in current assets minus current liabilities over a specified period.It is important to note that taxes have already been accounted for in the net income figure, which is why they are not separately subtracted in the free cash flow formula. Therefore, the appropriate way to incorporate the effective tax rate into the free cash flow calculation is by ensuring it is reflected within the net income figure, which includes revenue minus operating expenses, taxes, and other costs.