ACCA AFM Syllabus B. Advanced Investment Appraisal - Free cash flow to equity - Notes 10 / 11
Free CF to equity is the amount of cash available to pay out dividends
The dividend capacity of a company is measured by its free cash flow to equity.
Free cash flow to equity is equal to the Free CF after:
Deducting any interest payments and any loan repayments; and
Adding any cash inflows arising from the issue of debt.
The Dividend cover can be calculated as follows:
Dividend cover
= Free cash flow to equity/ Dividends paid
Illustration
Operating profit = $168
NCA = $1345
Income tax expense = $15
Interest on loan = $74
During the current year:
(1) Depreciation is charged at 10% per annum on the year end non-current asset balance and is included in other operating costs in the income statement.
(2) The investment in net working capital in Y0 was $220 and in Y1 increased to $240.
Required
Prepare a cash flow forecast for the business highlighting the free cash flow to equity (the dividend capacity).
Solution
| Projected cash flows | Year 1 |
|---|---|
| Operating profit | 168 |
| Add depreciation ($1340 x 10%) | 134 |
| Less incremental working capital ($240 -$220) | (20) |
| Less taxation | (15) |
| Less interest | (74) |
| –––––– | |
| Free cash flow to equity | 193 |