The Morning Star News Agency reported an operating profit of $140,000 in 2007. Its depreciation expense was $13,000, and it invested $20,000 in new equipment during the year.
In addition, its accounts receivable increased by $10,000; its inventory increased by $5,000, its
Accounts payable increased by $8,000; and its taxes payable decreased by $3,000. If the firm
Paid taxes of $14,000 in 2007, what was its free cash flow?

Question

Quizplus · Accepted Answer

Free cash flow can be calculated using the following formula:

Free Cash Flow = Operating Cash Flow - Capital Expenditures

First, we need to calculate the operating cash flow (OCF):

OCF = Operating Profit + Depreciation - Taxes

OCF = $140,000 + $13,000 - $14,000 = $139,000

Next, we need to calculate the capital expenditures (CapEx):

CapEx = Increase in Net Fixed Assets + Depreciation

CapEx = $20,000 + $13,000 = $33,000

Now we can calculate the free cash flow:

Free Cash Flow = OCF - CapEx

Free Cash Flow = $139,000 - $33,000 = $106,000

However, we also need to take into account the changes in working capital:

Change in Working Capital = Increase in Accounts Receivable + Increase in Inventory - Increase in Accounts Payable - Decrease in Taxes Payable

Change in Working Capital = $10,000 + $5,000 - $8,000 - (-$3,000) = $20,000

So the final free cash flow calculation is:

Free Cash Flow = OCF - CapEx + Change in Working Capital

Free Cash Flow = $139,000 - $33,000 + $20,000 = $126,000

Therefore, the correct answer is B) $109,000.

The Morning Star News Agency Reported an Operating Profit of $140,000