I calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios.

Question 1

Free Cash Flow

Answer 1

A measure of cash that is available for discretionary purposes once the firm has covered its capital expenditures. It is fundamental and often used for valuation.

Two common measures are ‘free cash flow to the firm’ and ‘free CF to equity’

Question 2

Free CF to the firm - FCFF (The cash available to both equity owners and debt holders ‘all investors’)

Answer 2

Start calc with either NI or operating CF

Start from NI: FCFF = NI + NCC (noncash charges: depreciation, amortization) + [Int x (1-T)-FCInv - WCinv *Note: Interest expense, net of tax, is added back to NI because interest is paid to Debt Holders (so its reflecting in NI)

‘Fixed capital investment’ (net capital expenditures)
-Cash spent on fixed assets - cash received from fixed asset sales, and is NOT CFI

Working capital investment

FCFF calculated from operating CF

FCFF = CFO + [Int x (1-T)] - FCinv

FCFF GOAL!!! Goal is to calculate the cash flow that is available to the shareholders and debt holders

Question 3

Free Cash Flow to Equity (Cash flow that is available for distribution to common shareholders)

Answer 3

Calc: FCFE = CFO - FCInv + ‘net borrowing’

Net Borrowing: Debt issued - Debt repaid (subtract from FCFE is borrowing > repayment)

If IFRS then any subtracted dividends paid must be added back in calculating CFO

Question 4

What are the two classes of CF ratios

Answer 4

Performance Ratios

Coverage Ratios

Question 5

Ex’s (5) of CF Performance Ratio

Answer 5

CF to Revenue ratio: Measures the amount of operating CF generated for each dollar of revenue = CFO/Net Revenue

Cash return-on-assets ratio measures the return of operating cash flow attributed to all providers of capital = CFO / Average Total Assets

Cash-return-on-equity ratio measures the return of operating cash flow attributed to shareholders = CFO / Average total Equity

Cash-to-income ratio measures the ability to generate cash from firm operations = CFO / Operating Income

Cash Flow Per Share is a variation of basic earnings per share measured by using CFO instead of N.I. = CFO - Preferred Dividends / Weighted Average Number of Common Shares
*If IFRS classifies common dividends as operating activities they should add back to CFO for purposes of calculating CF/share

Question 6

Ex’s (6) of Coverage Ratios

Answer 6

Debt coverage ratio measures financial risk and leverage = CFO / total debt

Interest coverage ratio measures the firms ability to meet its interest obligations = CFO +interest paid + taxes paid / interest paid
*If interest under IFRS is classified as a financing activity, no interest adjustment is needed

Reinvestment ratio measures the firms ability to acquire long-term assets with operating cash flow = CFO / cash paid for long-term assets

Debt payment ratio measures the firms ability to satisfy long-term debt with operating CF = CFO / Cash Long-term Debt Repayment

Dividend Payment Ratio measures the firms ability to make dividend payments from operating cash flow = CFO / Dividends paid

Investing and Financing ratio measures the firms ability to purchases assets, satisfy debts, and pay dividends = CFO / CAsh outflows from inesting and financing activities