EX 16-24 Free cash flow

Sweeter Enterprises Inc. has cash flows from operating activities of $539,000. Cash flows used for investments in property, plant, and equipment totaled $210,000, of which 75% of this investment was used to replace existing capacity.

a. Determine the free cash flow for Sweeter Enterprises Inc.
b. How might a lender use free cash flow to determine whether or not to give Sweeter Enterprises Inc. a loan?


Answer:

a. Cash flows from investment in PPE………………………………………………… $210,000
Replacement percentage……………………………………………………………… 75%
Cash paid for maintaining property, plant, and equipment…………………… $157,500
Cash flows from operating activities………………………………………………… $539,000
Less cash paid for maintaining property, plant, and equipment……………… 157,500
Free cash flow…………………………………………………………………………… $381,500

b. Free cash flow is often used to measure the financial strength of a business. The
more free cash flow that a business has, the easier it will be for the company to
pay the interest on the loan and repay the loan principal. Sweeter’s free cash flow
is $381,500, which is very strong.