What is Free Cash Flow? Free cash flow is a cash flow available in a company after paying operating expenses, debt and other obligations. It does not include the non cash expenses like depreciation. Formula: FCF =Net income + Depreciation + Interest expense*(1-tax rate)-Increase in net working capital-Capital expenditure . OR FCF =EBIT*(1-tax rate) + Depreciation-Increase in net working capital/+Decrease in net working capital-Capital expenditure Where, FCF=Free Cash Flow, EBIT = Earnings before Interest and Tax Capital expenditure = Cost of Asset Example: The LX Company wants to purchase a machine worth Rs. 90,000. The life of asset is 5 years and the salvage value is Rs. 2800. The increase in net working capital is Rs. 45,820.The earnings before interest and tax is Rs. 4, 50,000. The company tax rate is 35%. What is the free cash flow of a LX Company? Solution: Depreciation on machine: = (Cost of machine-Salvage value)/Useful life of machine
Geometric average return: It is an average rate of return that includes the compounding effects in multiple periods. Formula: GAR = (((1+R 1 )* (1+R 2 )*(1+R 3 )*(1+R 4 )....(1+R n ))^1/n) -1 Arithmetic return: It is an average of set of data of different periods. It is calculated by adding the return of some period and then dividing the number with the number of data. Formula: AR = (R 1 +R 2 +R 3 +R 4 ....R n )/n AR =Arithmetic return R 1 +R 2 +R 3 +R 4 ....R n = Rate of return N = Number of observations Example: Find out the Average return of 4 years rate of return in a given data: Year Rate of return 1 3.5% 2 -2.9% 3 6% 4 8.5% Solution: The average return of 4 years rate of return: AR = (R 1 +R 2 +R 3 +R 4 )/n = (3.5+ (-2.9)+6+8.5)/4 = 3.775% AR = Arithmetic return N =Number of periods Example: There are two stock are given Stock A and