Madura Inc.wants to increase its free cash flow by $180 million during the coming year,which should result in a higher EVA and stock price.The CFO has made these projections for the upcoming year:
∙EBIT is projected to equal $850 million.
∙Gross capital expenditures are expected to total to $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.
What increase in net operating working capital (in millions of dollars)would enable the firm to meet its target increase in FCF?

Question

Quizplus · Accepted Answer

Free cash flow is calculated as EBIT(1-tax rate)+Depreciation-Net capital expenditures-Net change in operating working capital.
We know that EBIT=$850 million, tax rate is 40% and Depreciation=$120 million.
Net capital expenditures= Gross capital expenditures-Depreciation = $360 million-$120 million =$240 million.
Also, there will be no changes in cash or marketable securities, notes payable or accruals.

Let's assume the net operating working capital increase required to meet the target free cash flow is X.

Thus, the equation becomes:
FCF = $850 million(1-0.40) + $120 million - $240 million - X

Solving for X, we get X = $90 million.

Therefore, an increase in net operating working capital of $90 million would enable the firm to meet its target increase in FCF, hence B) $90 million is the correct answer.