Short-term borrowing

Sales= $61,000, COGS=$37,000, Depreciation= $8,000, Interest expense= $1,000, Dividends paid= $1,500, Effective tax rate is 21%.

At the beginning of the year:

• NFA= $40,000
• CA: cash $3,000, inventory $3,000, AR $4,000
• CL: AP $2,500, NP $1,000, ST-borrowing $4,000
At the end of the year:

• NFA= $42,000
• CA: cash $3,500, inventory $6,000, AR $6,000
• CL: AP $3,000, NP 2,000, ST-borrowing $4,000
Compute the FCF at the end of the year.

To compute the Free Cash Flow (FCF) at the end of the year, we need to follow these steps:

### 1. Calculate Net Income
Net income can be calculated as follows:

\[
\text{Net Income} = (\text{Sales} - \text{COGS} - \text{Depreciation} - \text{Interest Expense}) \times (1 - \text{Tax Rate})
\]

Substituting the values:

\[
\text{Net Income} = (61{,}000 - 37{,}000 - 8{,}000 - 1{,}000) \times (1 - 0.21)
\]
\[
\text{Net Income} = (15{,}000) \times 0.79 = 11{,}850
\]

### 2. Add Back Depreciation
Depreciation is a non-cash expense, so we add it back to net income:

\[
\text{Operating Cash Flow (OCF)} = \text{Net Income} + \text{Depreciation}
\]
\[
\text{OCF} = 11{,}850 + 8{,}000 = 19{,}850
\]

### 3. Calculate Changes in Net Working Capital (NWC)
NWC is defined as Current Assets (CA) minus Current Liabilities (CL). We need to calculate the change in NWC from the beginning to the end of the year:

\[
\text{NWC at Beginning of Year} = (\text{Cash} + \text{Inventory} + \text{AR}) - (\text{AP} + \text{NP} + \text{ST-borrowing})
\]
\[
\text{NWC at Beginning of Year} = (3{,}000 + 3{,}000 + 4{,}000) - (2{,}500 + 1{,}000 + 4{,}000) = 10{,}000 - 7{,}500 = 2{,}500
\]

\[
\text{NWC at End of Year} = (3{,}500 + 6{,}000 + 6{,}000) - (3{,}000 + 2{,}000 + 4{,}000) = 15{,}500 - 9{,}000 = 6{,}500
\]

\[
\text{Change in NWC} = \text{NWC at End of Year} - \text{NWC at Beginning of Year} = 6{,}500 - 2{,}500 = 4{,}000
\]

### 4. Calculate Net Capital Expenditure (Net CapEx)
Net Capital Expenditure (Net CapEx) is the change in Net Fixed Assets (NFA) plus Depreciation:

\[
\text{Net CapEx} = (\text{NFA at End of Year} - \text{NFA at Beginning of Year}) + \text{Depreciation}
\]
\[
\text{Net CapEx} = (42{,}000 - 40{,}000) + 8{,}000 = 2{,}000 + 8{,}000 = 10{,}000
\]

### 5. Compute Free Cash Flow (FCF)
Finally, Free Cash Flow (FCF) is calculated as:

\[
\text{FCF} = \text{Operating Cash Flow (OCF)} - \text{Change in NWC} - \text{Net CapEx}
\]
\[
\text{FCF} = 19{,}850 - 4{,}000 - 10{,}000 = 5{,}850
\]

### **Conclusion**
The Free Cash Flow (FCF) at the end of the year is **$5,850**.

---

Would you like more details on any part of the calculation, or do you have any other questions?

Here are some related questions to explore:
1. How is Free Cash Flow (FCF) used in financial analysis?
2. What does a positive Free Cash Flow (FCF) indicate about a company’s financial health?
3. How does depreciation affect cash flow despite being a non-cash expense?
4. What are some strategies to improve Free Cash Flow (FCF)?
5. How does Free Cash Flow (FCF) differ from net income?

**Tip:** Free Cash Flow (FCF) is a crucial metric for assessing a company's financial flexibility, as it represents the cash available after accounting for capital expenditures needed to maintain or expand the asset base.

Learn how to calculate Free Cash Flow (FCF) using financial data including sales, cost of goods sold (COGS), depreciation, interest expense, dividends paid, and effective tax rate. Follow a step-by-step solution to compute FCF incorporating changes in net working capital and net capital expenditure. Suitable for college-level finance and accounting students.

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