Wells Water Systems recently reported $8,250 of sales,$4,500 of operating costs other than depreciation,and $950 of depreciation.The company had no amortization charges,it had $3,250 of outstanding bonds that carry a 6.75% interest rate,and its combined federal and provincial income tax rate was 35%.In order to sustain its operations and thus generate sales and cash flows in the future,the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating working capital.How much free cash flow did Wells generate?

A) $1,770.00
B) $1,858.50
C) $1,951.43
D) $2,049.00

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Paulina Maiguel · Accepted Answer

Final Answer : A, Explanation :  Free cash flow (FCF) can be calculated as follows:FCF = Operating cash flow – Capital expenditureswhere,Operating cash flow = EBIT*(1 − Tax rate) + Depreciation= ($8,250 − $4,500 − $950)*(1 − 0.35) + $950= $1,402.50Capital expenditures = Increase in net fixed assets + Increase in net operating working capital= $750 + $250= $1,000Therefore,FCF = $1,402.50 – $1,000 = $402.50So the best answer is A) $1,770.00 as $402.50 needs to be added to the net income of $1,367.50 to get the free cash flow of $1,770.00.

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