OCF = EBIT – Taxes + Depreciation
Second, we calculate the changes in working capital using the DSO, DSI and DPO ratios provided in the request form.
Capital Expenditure = Change in Net Working Capital
Net Working Capital = Current Asset – Current Liabilities
= A/R + Inventory – A/P
A/R = DSO * (Revenue / Number of days in Period)
Inventory = DSI * (COGS / Number of days in Period)
A/P = DPO * (COGS/ Number of Days in Period)
Afterwards we have all calculation available to estimate the Free Cash Flow (FCF), calculated as following
FCF = OCF – Capital expenditure
Referring to Exhibit 5, Executive VP of Manufacturing Robert Gates based his capital request form on a ten-year deal to estimate the project’s FCFs. However, from the information provided in the case we know that “the customer would commit to only a three-year contract”. Robert Gates financial assumptions expect capacity utilization to be increasing during the course of the project, but don’t take into account the operational risks that might occur from a changing “relationship with the customer” or a disappearing “demand (…) at the end of the initial three-year contract”.
Consequently, this would decrease revenue and reduce the FCF. Also, the risk measurement for a ten-year estimation shouldn’t be neglected. First, “making this (…) investment and incurring the associated debt (…) increases HPL’s (…) risk of financial distress should