Analyzing Cash Returned to Stockholders

Question 3

FCFE = Net Income – Net Capital Expenditure -Change in working Capital+ Change in debt
Initial working capital	Working capital after increase	Change in working capital
25,000,000	40,000,000	15,000,000
Net Income	Net Depreciation	Capital Expenditure	Change in working capital	FCFE
100,000,000	50,000,000	80,000,000	15,000,000	55,000,000

Free cash flow is a function of sources of cash less uses of cash. For Lube Oil, the free cash flow will be the total sources of cash (Net income & Depreciation), less the total uses of cash (Capital expenditure & Working capital needs).
𝐹𝐶𝐹=(𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒+𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)−(𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒+𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑛𝑒𝑒𝑑𝑠)

Where:

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒=$100𝑀
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛=$50𝑀
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒=$80𝑀
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑛𝑒𝑒𝑑𝑠=$40𝑀−$25𝑀=$15𝑀
Substituting the values into the equation:
𝐹𝐶𝐹=(100+50)−(80+15)
𝐹𝐶𝐹=$55𝑀

Question 4

Total Payout = Dividends + Share Repurchase( buyback)
Dividend Pay Out	Share Buy Back	Total Payout
$             20,000,000.00	$                    25,000,000.00	$           45,000,000.00
Cash Balance = FCFE – Payout
FCFE	Payout	Cash Balance
$             55,000,000.00	$                    45,000,000.00	$           10,000,000.00

The change in cash balance for the firm during the year is a function of the firm’s free cash flow less non regular expenditures.

First, we evaluate the firm’s free cash flow.

Free cash flow is a function of sources of cash less uses of cash. For Lube Oil, the free cash flow will be the total sources of cash (Net income & Depreciation), less the total uses of cash (Capital expenditure & Working capital needs).

𝐹𝐶𝐹=(𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒+𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)−(𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒+𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑛𝑒𝑒𝑑𝑠)

Where:

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒=$100𝑀
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛=$50𝑀
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒=$80𝑀
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑛𝑒𝑒𝑑𝑠=$40𝑀−$25𝑀=$15𝑀
Substituting the values into the equation:
𝐹𝐶𝐹=(100+50)−(80+15)
𝐹𝐶𝐹=$55𝑀

Next, we evaluate the non-regular expenditure incurred by the firm which include the dividend payment of $20M and the stock buyback of $25M.

𝑇𝑜𝑡𝑎𝑙 𝑜𝑛𝑒 𝑡𝑖𝑚𝑒 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒=𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑+𝑆ℎ𝑎𝑟𝑒 𝑏𝑢𝑦𝑏𝑎𝑐𝑘
𝑇𝑜𝑡𝑎𝑙 𝑜𝑛𝑒 𝑡𝑖𝑚𝑒 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒=$20𝑀+25𝑀=$45𝑀

Lastly, we evaluate the change in cash balance during the year.

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=𝐹𝐶𝐹−𝑃𝑎𝑦𝑜𝑢𝑡
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=$55𝑀−$45𝑀
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=$10𝑀

Question 5

Debt at the beginning of the year	Debt at the end of the year	Increase in Debt
$                               120,000,000.00	$                        135,000,000.00	$                               15,000,000.00
Previous FCFE	Increase in Debt	New FCFE
$                                 55,000,000.00	$                          15,000,000.00	$                               70,000,000.00
Previous Cash Balance	Increase in Debt	New Cash Balance
$                                 10,000,000.00	$                          15,000,000.00	$                               25,000,000.00

To evaluate the difference in previous answers due to the change in debt position, we evaluate the effect of the new debt figures.
Since the debt at the end of the year is more than the value at the beginning, there is an increase in debt during the year, which translates to an increase in sources of cash. An increase in the sources of cash, in turn, increases the free cash flow value and the cash balance.

𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑑𝑒𝑏𝑡=$135𝑀−120𝑀
𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑑𝑒𝑏𝑡=$15𝑀

Evaluate the change in free cash flow.

𝑁𝑒𝑤 𝐹𝐶𝐹=𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝐹𝐶𝐹+𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑐𝑎𝑠ℎ
𝑁𝑒𝑤 𝐹𝐶𝐹=$55𝑀+$15𝑀
𝑁𝑒𝑤 𝐹𝐶𝐹=$70𝑀

Next, evaluate the increase in cash balance.

𝑁𝑒𝑤 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒+𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑐𝑎𝑠ℎ
𝑁𝑒𝑤 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=$10𝑀+$15𝑀
𝑁𝑒𝑤 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒=$25M

Reference

Damodaran, A. (2010). Applied corporate finance. John Wiley & Sons.

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Week 9 Chapter 11 Questions

Select three formula-driven-problems from Chapter 11 that you wish to showcase and prepare a Microsoft Excel document showing the Excel formulas used to prepare the solution for those problems.

REMINDER: Part of the grade that you receive on your problems is the utilization of Formulas. Therefore, do not pick problems that only require a narrative!

Book:

Damodaran, A. (2010). Applied corporate finance. John Wiley & Sons.

• Chapter 11 Analyzing Cash Returned to Stockholders