Calculating Free Cash Flow (FCF)

Think of free cash flow (FCF) as another bottom line. Negative free cash flow isn't necessarily bad, but it suggests you're dealing with either a speculative investment or an underperformer. Above all, negative free cash flow usually equates to a high level of capital spending that naturally raises other questions. If the company is spending so much money on capital projects, is it at least earning a high return on that capital? Is the company’s IRR > WACC? And is all that spending paying off in rapid sales and profit growth?

The relevancy of free cash flow is that it represents “real cash,” earnings do not.

Calculation for free cash flow is as follows:

1. FCF = NOPAT – Net Investment in Operating Capital
a. NOPAT = EBIT(1-Tax Rate)
b. Net Investment in Operating Capital = [Cash + Accounts Receivable + Inventories – (Accounts Payable + Accruals)] (Net Operating Working Capital) + Operating Long-term Assets (Net Plant and Equipment)

2. FCF = (NOPAT + Depreciation) – Gross Investment in Operating Capital
a. NOPAT = EBIT(1-Tax Rate)
b. Gross Investment in Operating Capital = [(Net Operating Working Capital + Operating Long-term Assets) + (Depreciation)]

Uses of FCF
1. Pay interest to debt-holders
2. Repay debt-holders
3. Pay dividends to shareholders
4. Repurchase stock from shareholders
5. Purchase marketable securities or other non-operating assets

MBA 642 Financial Management: Million Dollar Challenge!

Next Tuesday, February 27, I am going to have Dr. Oglesby place the class into teams. Each team will select a facilitator and proceed to register for the "Million Dollar Portfolio Challenge" that is being sponsored by CNBC. I thought this would be a great way to see if any of you can win the million dollars. Thanks to Daniel Webster for bringing this to my attention.

Once the facilitator is selected, he or shee will register his/her team on CNBC for the “Portfolio Challenge.” See instruction below. I will the computer lab open so that each group can start the million dollar process. Good luck!
1. Go to CNBC (http://www.cnbc.com)
2. Click-on “Investing Tool.”
3. Click-on “Portfolio Challenge” to register.
4. Complete the registration procedure.
5. Challenge starts March 5, 2007

Stock Market Rallies

As we start to look at the various stock valuation models, it is always a good ideal to reflect upon where the market is today in relation to its performance and length of its current bullish trend.

As the following chart indicates, the current bullish rally is approximately 4.5 years in duration, which is long by previous market rallies. In addition, its current performance during this rally is approximately +75% over the past 4.5 years, which is lags behind previous market rallies. Also, the current rally is below its linear-regression trend line. Will we have a revision to the mean (point on the line) or will this market rally continue to underperform?

Fama and French Three-Factor (Predictor) Model

CAPM uses a single factor, beta, to compare a portfolio with the market. Why use more factors (predictors)?

Fama and French started with the observation that two classes of stocks have tended to do better than the market as a whole: (1) small caps [SML] and (2) stocks with a high book-value-to-price ratio [HML]. When they tested their hypothesis, they found small companies and companies with high B/M ratios had higher rates of return than the average stock (just as they hypothesized). Somewhat surprising by their research, however, they found no relation between beta and return.

They added two additional factors (predictors) to CAPM to reflect a portfolio’s exposure to size and B/M. The three-factor model is as follows:

ri = rf + bi(MRP) + ci(SMB) + di(HML) + alpha

One thing that is interesting is that Fama and French still see high returns as a reward for taking on high risk. For example, if returns increase with B/M, then stocks with high B/M ratio must be more risky than low B/M. Why?

Buy, Hold, or Sell

From the following weekly chart of IWO, determine the relationship between and among Commodity Channel Index (CCI), Full Stochastics, and Percentage Price Oscillator (PPO) in relation to forecasting the price direction of the underlying security?

OER or It's All About Data Analysis

From your analysis of the article (Manning the OER), which will be handed out in class, why are intermediate (10 year) and long (30 year) Treasuries not rallying in the face of “OER’s” weakness? Also, the Fed’s target for core inflation is between 1% and 2%. What is the current core inflation rate? In addition, what is the prospect for the core inflation rate during 2007?

January Indicator of Future Stock Performance

As goes January, so goes the year. This particular phenomenon is what is referred to as the “January Barometer.” The following chart, which is from “Chart of the Day.com,” presents the average performance of the S&P 500 one, three, six, and 11 months following a January gain (blue bars) and following a January loss (gray bars). The chart illustrates that the S&P 500 has performed much better (on average) during the months following a January gain. In fact, 11 months following a January gain; the S&P 500 was up 89% of the time. For January 2007, the S&P 500 was up 1.4%.

The "January Indicator" has an impressive record. Does the indicator imply that since the market was up in January that eleven months from now the S&P 500 will rise over 12%? Evaluate the aforementioned question. In your evaluation, what type of information would you want to know?