Question

In the learning objectives for this quiz, we focused on two methods to determine how much cash is available for dividend payments.

Residual distribution method, and by using free cash flow. For your project and the analysis of the public company, the free cash flow method would be a good approach for analysis. So, given the following data for Year-1:
Net Income = $4 million;
Depreciation = $2 million;
Investment in fixed assets = $1 million;
Investment in net working capital = $500,000.

Principal payments on debt were $1 million. New debt raised totaled $1.0 million during the period. Calculate the free cash flow to equity (FCFE) for Year 1 (please show your work):

Answer 1

To calculate the free cash flow to equity (FCFE) for Year 1, subtract the investments made in fixed assets and net working capital from the net income, and add back the depreciation expense. In this case, FCFE is $4.5 million.

Step-by-step explanation:

To calculate the free cash flow to equity (FCFE) for Year 1, we need to subtract the investments made in fixed assets and net working capital from the net income, and then add back the depreciation expense.

Net Income - (Investment in Fixed Assets + Investment in Net Working Capital) + Depreciation

In this case, the calculations would be as follows:
Net Income = $4 million
Depreciation = $2 million
Investment in Fixed Assets = $1 million
Investment in Net Working Capital = $500,000

FCFE = $4 million - ($1 million + $500,000) + $2 million = $4 million - $1.5 million + $2 million = $4.5 million

Free cash flow to equity (FCFE) is the amount of cash a business generates that is available to be potentially distributed to shareholders. It is calculated as Cash from Operations less Capital Expenditures plus net debt issued.