Managers strive to increase the value of a firm. An increase in the intrinsic value of the firm’s stocks is a good measure of the increase in the value of the firm. Intrinsic value of a firm’s stock price is determined by calculating the present values of its free cash flows (FCF) discounted at a rate called the weighted average cost of capital (WACC). Tyler is a team member in Corporate Finance at a digital-content production company. He is required to forecast the free cash flows that the company will be able to generate in the next three years. Tyler takes into account only the following equation in his calculation: FCF = Sales Revenues – Operating Costs – Operating Taxes Will his calculation be an appropriate estimate of the FCF? No Yes Why or why not? Check all that apply. Because his calculation fails to include both the working capital and capital expenditures necessary to sustain the company’s operations Because his calculation fails to include the increase in the working capital required to grow sales Because his calculation fails to include the costs of the firm’s interest and dividend payments Because his calculation fails to recognize the increase in sales revenues

Free Cash Flow (FCF) can simply be defined as the net flow for a company after taking account of cash operating expenses, taxes (some textbooks may omit this), and investments in working capital and capital expenditure required to sustain continuous business operations.

As such, an appropriate formula for FCF would be:

sales revenue - cash operating cost (this will exclude depreciation) - operating taxes - investment in working capital - capital expenditure.

Tyler's formula did not include investment in working capital and capital expenditure, thus making it incomplete.