Question

Problem 3-24 Free Cash Flow (LO3)

The following table shows an abbreviated income statement and balance sheet for Quick Burger Corporation for 2016.

INCOME STATEMENT OF QUICK BURGER CORP., 2016
(Figures in $ millions)
Net sales	$	27,575
Costs		17,577
Depreciation		1,410
Earnings before interest and taxes (EBIT)	$	8,588
Interest expense		525
Pretax income		8,063
Taxes		2,822
Net income	$	5,241

BALANCE SHEET OF QUICK BURGER CORP., 2016
(Figures in $ millions)
Assets	2016				2015				Liabilities and Shareholders' Equity	2016				2015
Current assets									Current liabilities
Cash and marketable securities		2,344				2,344			Debt due for repayment		—				391
Receivables		1,383				1,343			Accounts payable		3,411				3,151
Inventories		130				125			Total current liabilities		3,411				3,542
Other current assets		1,097				624
Total current assets		4,954				4,436
Fixed assets									Long-term debt		13,641				12,142
Property, plant, and equipment		24,685				22,843			Other long-term liabilities		3,065				2,965
Intangible assets (goodwill)		2,812				2,661			Total liabilities		20,117				18,649
Other long-term assets		2,991				3,107			Total shareholders’ equity		15,325				14,398
Total assets		35,442				33,047			Total liabilities and shareholders’ equity		35,442				33,047

In 2016 Quick Burger had capital expenditures of $3,057.

a. Calculate Quick Burger’s free cash flow in 2016. (Enter your answer in millions.)

b. If Quick Burger was financed entirely by equity, how much more tax would the company have paid? (Assume a tax rate of 35%.) (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

c. What would the company’s free cash flow have been if it was all-equity financed?

Answer 1

1. Calculate Quick Burger’s free cash flow in 2016

Cash flow from operations = Net Income + Interest + Depreciation – Additions to Net Working Capital

Free Cash Flow = Cash Flow from Operations – Capital Expenditures

Additions to Net Working Capital = ($3,411 − $3,151) − ($1,383 − $1,343) − ($130 − $125) − ($1,097 − $624) = -$258

Cash Flow from Operations = $5,241 + $525 + $1,410 - $258 = $6,918

Capital Expenditures = $3,057

Free Cash Flow (FCF) = $6,918 – $3,057 = $3,861

2. If Quick Burger was financed entirely by equity, how much more tax would the company have paid? (Assume a tax rate of 35%.)

If the firm was entirely financed by Equity, the Tax would have been computed on $8,588 i.e. $8,588*0.35 = $3006.

Tax increase due to $525 million more in taxable income (525 × 0.35) = $184 Million

3. What would the company’s free cash flow have been if it was all-equity financed?

Cash flow from operations = Net Income + Depreciation – Additions to Net Working Capital

Free Cash Flow = Cash Flow from Operations – Capital Expenditures

Additions to Net Working Capital = ($3,411 − $3,151) − ($1,383 − $1,343) − ($130 − $125) − ($1,097 − $624) = -$258

Cash Flow from Operations = $5582 (refer note) + $1,410 - $258 = $6,734

Free cash flow = $6,734 − $3,057 = $3,677

Note : Revised Net Income = $5,241 + [$525-($525*0.35)] = $5582