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Meriden Products: The Free Cash Flow Case Study

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Updated: May 5th, 2022

The values of ebitda for the three years are $38,000 for 2004, $48,790 for 2005 and $63,840 for 2006. Free cash flow had two optional definitions. One definition was the cash flow from operations minus the capital spending. The second definition was the cash flow from operations minus the capital spending and minus dividends (Almeida, Campello & Weisbach 3). The table below displays the free cash flow for Meriden Products for the three years.

2004 ($) 2005 ($) 2006 ($)
Cash flow from operations 11,889 9,992 8,725
Capital Spending (13,219) (20,522) (28,835)
Free Cash flow 25108 30514 37560

Cash flow from operation shows positive values less than the values of free cash flows for the three years. Free cash flow for the three years shows a positive incremental growth as years go by. All the values of ebitda are greater than the cash flow from operations through the three years.

For the pessimistic scenario, the calculation of ebitda and free cash flow remains the same as in the previous calculations. The formula for ebitda will be ebitda=net income + depreciation and the formula for free cash flow is cash flow from operation less capital spending. The table below contains the results.

Ebitda

2007 ($) 2008 ($) 2009 ($)
Net Income 13,600 11,500 10,900
Depreciation Expense 9,400 9,400 9,400
Ebitda 23,000 20,900 20,300

Free Cash Flow

2007 ($) 2008 ($) 2009 ($)
Cash flow from operations 23,000 24,000 24,400
Capital Spending (9,400) (9,400) (9,400)
Free Cash flow 32400 33400 33800

For the pessimistic scenario, the ebitda value for the first year equals that of the corresponding cash flow from operations, and for the remaining two years, ebitda is less than the cash flow from operations. Cash flows from operation values are less than the free cash flows for the three years. Free cash flow for the three years shows a positive incremental growth.

The use of ebitda has both advantages and disadvantages which the table below shows.

Advantages Disadvantages
Ebitda focuses on cash flow operating items by excluding depreciation and amortization as non-cash expenses. It excludes vital negative cash flow components such as interest and taxes, which gives inaccurate calculations of cash flow.
It creates advantage in buyouts for the management to raise cash for the privatization of the firm by taking on large amounts of debts. It does not consider the need for continual financing of working capital, for accounts receivable and inventory.
It does not consider the importance of the going concern in accounting.

The use of free cash flow poses advantages and disadvantages as the table below indicates.

Advantages Disadvantages
It lays more emphasis on the core cash flow from which the management can choose. It is not easy to separate the amount of capital spending from the cost of the expansion with new equipment.
A firm remains with a core cash flow to dedicate to various needs, after replacing the productive capacity that the firm has consumed. It is possible to understate its value since it leaves out capital spending and depreciation.

If I were Jim, I would tell the president that pro-forma figures would require too much disclosure of sensitive and confidential information to third parties, such as the investor, about the firm’s financial performance (McDonald 1777). I would convince him that there is no need for pro-forma numbers.

Works Cited

Almeida, Heitor., Murillo Campello & Michael Weisbach. Cash Flow Sensitivity. New York: New York University. 2004. Print.

McDonald, Robert. Cash Flow from Operations- Do We Need Any Other Cash Flow Terms? Chicago: University of New Haven, 2010. Print.

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