Thesis: Free Cash Flows and Investment Decisions

Sample Thesis Paper

The free cash flow slightly differs from the net cash flow of a company. The net cash flow of a company is calculated by including the non cash adjustments in the net income of the company. Brigham and Ehrhardt (2001) defined free cash flow as: “The cash flow actually available for distribution to investors after the company has made all the investments in fixed assets and working capital necessary to sustain ongoing operations” (p.46). Free cash flow is the remaining amount of cash after the company has generated and used the fixed assets in operating and investing activities. This cash flow is available to be distributed to shareholders or to be invested in projects for generating higher cash flows in the future.

Earnings before Interest Taxes Depreciation and Amortization – EBTDA is sometimes used in place of the free cash flows to evaluate investment decisions but EBITDA is quite different from free cash flows and does not provide a true reflection of the free cash flows as it includes the non cash items in earnings, does not account for cash requirements in the working capital and does not include the cash expenditure required for capital investments. The free cash flows thus have to be calculated by implementing all these components of non cash items, cash requirements in the working capital and cash requirement for fixed assets (Christy 2006).

The free cash flow of a company is used in various investment decisions such as capital budgeting techniques of NPV, IRR and payback period of specific projects. All the capital budgeting techniques used for evaluating the feasibility of investment decisions and estimating the profitability of projects implement free cash flows in calculations. This entails that the free cash flows are necessary to evaluate the feasibility and profitability of any investment decision. When the capital budgeting techniques have been analysed the company can implement the investment decision and accept or reject a particular project based on the results of these techniques (Damodaran 2002).

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