Free Cash flow is the amount of free cash available for a firm to invest in various projects for future operations or to gain higher returns. The free cash flows are used in the estimation of various models of capital budgeting techniques like Net Present Value, IRR and Payback period.
The free cash flows are further discounted by applying a particular discount rate to achieve the present values of these cash flows. The free cash flows of a firm during a period can be estimated by adding the non cash expenses such as depreciation and amortization to the net operating profit after tax and deducting the amount of changes in working capital and the gross expenditure on fixed assets from this sum. The mathematical equation for this statement would be:
Free Cash Flow = Net Operating Profit after Tax + Non Cash Expenses – (Gross Fixed Assets Expenditures + Changes in working capital)
Brigham, E. and M. Ehrhardt. Financial Management: Theory and Practice 11th Edition. Florence: South-Western Educational Publishing, 2001.
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