Question

Free cash flow (FCF) and net income (NI) differ in the following ways:

I) Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated before interest.

II) Net income is calculated after various noncash expenses, including depreciation; FCF adds back depreciation.

III) Capital expenditures and investments in working capital do not appear in net income calculations; however, they do reduce free cash flows.

IV) Net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments can exceed cash flows from operations.

a.

I only

b.

I and II only

c.

I, II, and III only

d.

I, II, III, and IV

Answer 1

c. I, II, and III only

Step-by-step explanation:

As we know that

Free cash flow = Earnings before Interest and Taxes × (1-Tax Rate) + Amortization and Depreciation expense - Change in Net Working Capital -Capital Expenditure

And, the Net income is determined after considering all cash and non cash expenses.

Therefore, I, II and III statements are considered

Hence, the option c is correct