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Hello,
In this past paper on the ACCA website – we are asked to calculate the dividend capacity in Q2a for Cadnam Co.
The question states:
The investment required to keep the non-current asset base at its present productive capacity in 20X6 will be $2,430m, which has been included in the calculation of operating profit as depreciation.Why has this amount has not been deducted from the operating profit to calculate FCFE?
I can see it says this amount has been included in operating profit as depreciation, however does this not mean we still have to deduct to obtain FCFE to the firm?
Thanks,
Raheel
Depreciation is not a cash flow and therefore we would usually add it back to the operating profit in order to arrive at the free cash flow.
However since the same amount is being spent on the non-current assets there is a cash outflow.So rather than add back and then subtract the same amount, we might as well just ignore both 🙂
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