Below is a pro forma income statement for the next year (year 1). Everything is in million $.

Year 1
Sales 120
Costs 70
EBITDA 50
Depreciation 20
EBIT 30
Interest Expense 5
Pre-Tax Income 25
Income tax 5
Net Income 20

The company will not have any capital expenditures in year 1, but it will increase the level of NWC from $10 million (in year 0 ) to $14.4 million in year 1. The corporate tax rate is 20%.

What is the free cash flow in year 1? Write your answer in million dollars with 1 digit after the decimal point. For example, if the answer is $3.2 million, just write 3.2.

Question

Below is a pro forma income statement for the next year (year 1).  Everything is in million $.

Year 1
Sales	120
Costs	70
EBITDA	50
Depreciation	20
EBIT	30
Interest Expense	5
Pre-Tax Income	25
Income tax	5
Net Income	20

The company will not have any capital expenditures in year 1, but it will increase the level of NWC from $10 million (in year 0 ) to $14.4 million in year 1.  The corporate tax rate is 20%.

What is the free cash flow in year 1?  Write your answer in million dollars with 1 digit after the decimal point. For example, if the answer is $3.2 million, just write 3.2.

BlackTom AI · Accepted Answer

First, identify the key components needed to compute free cash flow for year 1. We have EBIT of 30 million, depreciation of 20 million, no capital expenditures in year 1, and a change in net working capital from 10 million to 14.4 million, which is an increase of 4.4 million. The tax rate is 20%.

Step 1: Compute after-tax operating income (NOPAT). NOPAT = EBIT × (1 − tax rate) = 30 × (1 − 0.20) = 30 × 0.80 = 24 million.

Step 2: Add back non-cash charges. Depreciation is a non-cash expense, so we add it back to NOPAT when calculating free cash flow. 24 + 20 = 44 million.

Step 3: account for the investment in net working capital. Free cash flow reduces by the amount of net working capital invested (ΔNWC). Since NWC increases by 4.4 million, this is an outflow that lowers FCF: 44 − 4.4 = 39.6 million.

Step 4: consider capital expenditures. The problem states there are no capital expenditures in year 1, so no subtraction is needed for capex.

Step 5: finalize. Therefore, the free cash flow in year 1 is 39.6 million dollars.

Notes and cross-checks:
- Another common formula is FCF = EBIT(1 − tax) + Depreciation − ΔNWC − Capex. Substituting gives 30 × 0.80 + 20 − 4.4 − 0 = 24 + 20 − 4.4 = 39.6, which matches the result above.
- If you mistakenly used net income instead of EBIT for the starting point, you’d undercount by the tax shield on interest and depreciation effects, leading to an incorrect FCF.

SP2025.B62.FIN.534 Quiz 2 (Lecture 2)

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