Tareque Inc.wants to increase its free cash flow by $180 million during the coming year,which should result in a higher EVA and share price.The CFO has made these projections for the upcoming year:- EBIT is projected to be $850 million.- Gross capital expenditures are expected to total $360 million versus depreciation of $120 million,so its net capital expenditures should total $240 million.- The tax rate is 40%.- There will be no changes in cash or marketable securities,nor will there be any changes in notes payable or accruals.Which of the following actions would enable the company to achieve its goal of generating $180 million in free cash flow?

Question

Quizplus · Accepted Answer

Free cash flow can be calculated using the formula: FCF = EBIT*(1-Tax rate) + Depreciation - Net capital expenditures. 
Substituting the given values, we get: 
FCF = $850*(1-0.4) + $120 - $240 = $510 million 
To increase FCF by $180 million, the company needs to generate an additional $180 million. 
One of the ways to achieve this is by increasing accounts receivable, inventory, and accounts payable. 
Option B suggests an increase in accounts receivable by $470 million and inventory by $230 million, but also an increase in accounts payable by $610 million. This can increase FCF as follows: 
FCF = $850*(1-0.4) + $120 - ($240 + $610 - $470 - $230) = $690 million 
($240 is the net capital expenditure and the difference between accounts payable and accounts receivable and inventory is the change in working capital) 
Therefore, Option B is the best choice.