Free cash flow to equity

NotesPaper exam

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:

  1. Deducting any interest payments and any loan repayments; and

  2. 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
NotesPaper exam