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Finance · level 2

Project free cash flow

Capital budgeting values cash, not earnings. Start from unlevered net income, add back the non-cash depreciation, take out what you actually spend on assets and working capital.

Theory: Corporate Finance 

Worked example: Year-3 project numbers: revenue $70M, EBITDA margin 25%, depreciation $7M, tax 21%, capex $4M, change in NWC +$2M. Free cash flow?

EBIT$10.5M
NOPAT$8.3M
+ dep − capex − ΔNWC$7M / $4M / $2M
FCF$9.3M

Step by step

  1. 1

    EBIT

    $70M × 25% − $7M = $10.5M

  2. 2

    Unlevered net income

    $10.5M × (1 − 21%) = $8.3M

  3. 3

    Add back, subtract, subtract

    $8.3M + $7M − $4M − ($2M) = $9.3M

  4. 4

    Berk & DeMarzo reminders

    Ignore interest (it is in the discount rate), ignore sunk costs, include opportunity costs and cannibalisation, use incremental numbers only.

Year-3 project numbers: revenue $70M, EBITDA margin 25%, depreciation $7M, tax 21%, capex $4M, change in NWC +$2M. Free cash flow? = 9,295,000

The theory behind it

Intuition

Finance is time and risk applied to cash: move every cash flow to the same date at a rate that reflects its risk, then compare.

Common pitfalls

  • ×Discounting a nominal flow at a real rate (or vice versa).
  • ×Mixing enterprise-value and equity-value numbers in the same ratio.

In the interview

Valuation, WACC, LBO and accretion rounds — where a wrong bridge is a wrong answer.