Overview
This lecture covers the concept of cash flow from assets in corporate finance, detailing key formulas, calculation methods, and its relevance to project evaluation.
Cash Flow from Assets: Core Concept
- In corporate finance, focus is on cash generated from assets and how it's distributed to those who finance them.
- Cash flow from assets can be calculated in two main ways.
Method 1: Operating Cash Flow Approach
- Cash Flow from Assets = Operating Cash Flow – Net Capital Spending – Change in Net Working Capital.
- Operating Cash Flow = Earnings Before Interest and Taxes (EBIT) + Depreciation – Taxes.
- Depreciation is added back as it is a non-cash expense, though it reduces taxable income.
- Net Capital Spending = Ending Net Fixed Assets – Beginning Net Fixed Assets + Depreciation.
- Change in Net Working Capital = (Ending Current Assets – Ending Current Liabilities) – (Beginning Current Assets – Beginning Current Liabilities).
Method 2: Cash Flow to Creditors and Stockholders
- Cash Flow from Assets = Cash Flow to Creditors + Cash Flow to Stockholders.
- Cash Flow to Creditors = Interest Paid – Net New Borrowing (change in total debt).
- Cash Flow to Stockholders = Dividends Paid – Net New Equity Raised.
Example Calculations
- Both calculation methods should yield the same cash flow from assets when applied correctly.
- The example uses balance sheet and income statement figures to demonstrate both calculation methods.
Application in Project Evaluation
- These cash flow concepts are foundational for analyzing and evaluating capital budgeting projects.
- Tools like Net Present Value (NPV) and Internal Rate of Return (IRR) depend on accurate cash flow estimation.
Key Terms & Definitions
- Cash Flow from Assets — Total cash generated from asset use, after considering capital spending and changes in working capital.
- Operating Cash Flow (OCF) — EBIT plus depreciation, minus taxes; measures cash generated from operations.
- Net Capital Spending — Net spending on fixed assets, considering depreciation.
- Net Working Capital — Current assets minus current liabilities.
- Cash Flow to Creditors — Interest paid minus net new borrowing.
- Cash Flow to Stockholders — Dividends paid minus net new equity.
Action Items / Next Steps
- Practice calculating cash flow from assets using both methods on provided financial statements.
- Review the relationship between cash flow calculation and project evaluation tools like NPV and IRR.