In terms of DCF, how should "free cash flow" be calculated?

Free cash flow is a critical metric in discounted cash flow (DCF) analysis that helps determine the cash generated by a business that is available for distribution to its investors after necessary capital expenditures (CapEx) have been subtracted. The calculation involves starting with operating cash flow, which reflects the cash generated from the core operations of the business. From this operating cash flow, capital expenditures are deducted since these are necessary investments to maintain or expand the asset base of the business.

This approach provides a clear picture of the cash available to equity holders and debt holders, making it essential for valuation purposes. Since free cash flow incorporates both operating performance and required reinvestment, it offers a more comprehensive view of financial health compared to simple profit measures, such as revenue minus operating expenses or net income after taxes, which do not reflect the cash impact of capital expenditures.

As a result, the calculation of free cash flow as operating cash flow minus capital expenditures accurately captures the cash that can be freely used for dividends, debt repayment, or reinvestment in the business, making it the appropriate method for this context.