How do you calculate free cash flow in a DCF model?

How do you calculate free cash flow in a DCF model?

• A. Net income plus depreciation
• B. Operating cash flow minus capital expenditures
• C. Revenue minus expenses
• D. Operating profit plus taxes

Answer: (B)

In a discounted cash flow (DCF) model, free cash flow is calculated as operating cash flow minus capital expenditures. This approach accurately reflects the cash generated by a company's operations that is available for distribution to investors after accounting for necessary investments in business infrastructure. Operating cash flow is derived from how well a company can generate cash from its core operating activities, including adjustments for changes in working capital. Capital expenditures represent the investments a company makes to maintain or expand its asset base, such as purchasing new equipment or upgrading existing facilities. By subtracting these expenditures from operating cash flow, the result is a figure that indicates how much cash is available for debt repayment, dividends, and reinvestment in the business, which is crucial for valuing a company in a DCF model. This emphasis on cash flow clarifies the company's ability to create value, making it a critical component of financial analysis in valuing a business. Other methods mentioned do not provide a complete view of free cash flow or do not align with the standard valuation practices utilized in a DCF analysis.

In a discounted cash flow (DCF) model, free cash flow is calculated as operating cash flow minus capital expenditures. This approach accurately reflects the cash generated by a company's operations that is available for distribution to investors after accounting for necessary investments in business infrastructure.

Operating cash flow is derived from how well a company can generate cash from its core operating activities, including adjustments for changes in working capital. Capital expenditures represent the investments a company makes to maintain or expand its asset base, such as purchasing new equipment or upgrading existing facilities. By subtracting these expenditures from operating cash flow, the result is a figure that indicates how much cash is available for debt repayment, dividends, and reinvestment in the business, which is crucial for valuing a company in a DCF model.

This emphasis on cash flow clarifies the company's ability to create value, making it a critical component of financial analysis in valuing a business. Other methods mentioned do not provide a complete view of free cash flow or do not align with the standard valuation practices utilized in a DCF analysis.