The 2013 income statement for Lou's Shoes shows that depreciation expense is $2 million, EBIT is $5 million, EBT is $3 million, and the tax rate is 40 percent. At the beginning of the year, the balance of gross fixed assets was $16 million and net operating working capital was $6 million. At the end of the year gross fixed assets was $20 million. Lou's free cash flow for the year was $4 million. What is their end of year balance for net operating working capital?

Question

Quizplus · Accepted Answer

- First, let's calculate Lou's operating cash flow (OCF) for the year:
OCF = EBIT + Depreciation - Taxes
OCF = $5M + $2M - ($3M * 0.40)
OCF = $5M + $2M - $1.2M
OCF = $5.8M

- Next, we need to calculate the change in net operating working capital (NOWC) for the year:
NOWC = Ending NOWC - Beginning NOWC
NOWC = ? - $6M

- Finally, we can use the formula for free cash flow (FCF) to solve for the missing variable:
FCF = OCF - Change in NOWC - Net Capital Expenditures
$4M = $5.8M - (NOWC - $6M) - (Ending Gross Fixed Assets - Beginning Gross Fixed Assets)
$4M = $5.8M - NOWC + $6M - ($20M - $16M)
$4M = $5.8M - NOWC + $2M
NOWC = $3.8M

Therefore, the end of year balance for net operating working capital is $3.8 million. Answer: B.

The 2013 Income Statement for Lou's Shoes Shows That Depreciation