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Meaning / Definition of

Free Cash Flows

Categories: Finance,

Cash not required for operations or for reinvestment. Often defined as earnings before interest (often obtained from the operating income line on the income statement) less capital expenditures less the change in working capital. In terms of a formula: free cash flows = Sales (Revenues from operations) - COGS (cost of goods sold-labor, material, book depreciation) - SG&A (Selling, general administrative costs) EBIT (earnings before interest and taxes or operating earnings) - Taxes (cash taxes) EBIAT (Earnings before interest after taxes) + DEP (book depreciation) - CAPX (capital expenditures) - ChgWC (Change in working capital) C (free cash flows) There is an issue as to whether you want to define the FCFs to the firm as a whole (the cash flow to all of its security holders), or the FCFs only to the firm's equity holders. For firm valuation, you want the former; for stock valuation you want the latter. To value the firm, calculate the stream of FCFs to the firm and discount this stream by the firm's WACC (weighted average cost of capital). This will give you the value of a levered firm, including the tax benefits of debt financing. Alternatively, you can discount the firm's FCFs by its unlevered cost of capital and add separately the present value of the tax benefits. To value the firm's equity, you can either take the above number and subtract the market value of all outstanding debt (liabilities) or you can calculate the FCFs to the firm's equity holders and discount this stream by the firm's levered equity cost of capital. Notice that changes in working capital have the same effect on free cash flows as do changes in physical capital, i.e., capital expenditures. For example, suppose you had to spend $XX to increase the capacity of your plant. This expenditure would be a reduction in free cash flow in the year it was made. Likewise, if you had to increase the level of your cash balance, inventory or receivables by $XX to accommodate greater sales, then this too would result in a like reduction in free cash flows in the year the level of working capital was increased. [Definition and discussion courtesy of Professor Michael Bradley.]

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Definition / Meaning of

Tax Exempt

Categories: Finance,

Some investments are tax exempt, which means you don't have to pay income tax on the earnings they produce.For example, the interest you receive on a municipal bond is generally exempt from federal income tax, and also exempt from state and local income tax if you live in the state where the bond was issued. However, if you sell the bond before maturity, any capital gain is taxable.Similarly, dividends on bond mutual funds that invest in municipal bonds are exempt from federal income tax. And for residents of the issuing state for single-state funds, the dividends are also exempt from state and local taxes. capital gains on these funds are never tax exempt.Earnings in a roth ira are tax exempt when you withdraw them, provided your account has been open for five years or more and you're at least 59 1/2 years old. And earnings in 529 college savings plans and coverdell education savings accounts (ESAs) are also tax exempt if the money is used to pay qualified education expenses.When an organization such as a religious, educational, or charitable institution, or other not-for-profit group, is tax-exempt, it does not owe tax of any kind to federal, state, and local governments. In addition, you can take an income tax deduction for gifts you make to such organizations.

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