In this workout, we're going to calculate the cash flows available for debt service for a company called Maygee Limited. And we're going to do it for the years from year zero all the way to year eight.

So now what we're going to do first is we're going to calculate the net income number and the operating profit is just calculated by taking the sales minus the operating expenses. And that will give us 650. Then we've got the net income calculation, which is the operating profit minus the interest expense minus the tax expense to give us net income. And we'll do the same for all the years to year eight. Let me just fix that. I'll print profit number to year eight.

Then the cash flow statement, I can pull in the net income number to the top of the cash flow statement as you'd normally expect it to be seen. And then for my operating cash flow, I'll sum up these items. And this is just a standard cash flow statement we're seeing here.

And then we've got the investing cash flow, which in this case is just the capital expenditure. So this is a standard cash flow statement. And then we've got the financing cash flows, which is just in this case, dividends. That's it. So I'm gonna copy that across. And then finally, I'm going to do my net cash flow, which is the operating cash flow plus the investing cash flow plus the financing cash flow. So this is a standard cash flow statement that you would see in a normal forecast model for a company. Now we're going to contrast this to the free cash flows. And the free cash flows are called free cash flows because they represent the cash that is freely available to both debt and equity holders. Now, compare this to what we've been doing so far. Our cashflow statement started with net income and net income includes the servicing of interest expense. So net income by definition is affected by some payments to debt holders. Not only that, in our financing cash flow, we have dividends which are paid to equity holders. Now, our idea behind the free cash flows is that we're going to remove both those items. And in order to do this, we're going to start at our operating profit number. And the operating profit number is in the income statement, starting with 650. And I'm gonna copy that all the way to year number eight. Then what I'm going to do is calculate net operating profit after tax. And this is sometimes known as unlevered net income. In other words, it's the net income the company would have if it had no interest on the income statement. If it had no interest on the income statement, the profit before tax would equal operating profit. So in order to calculate NOPAT, I'm gonna take the operating profit and I'm gonna multiply it by open parentheses, one minus the tax rate, and I'm gonna hit enter, and I get my net operating profit after tax. Now, in this case, we're using the effective tax rate because you're assuming that's reflecting the long-term tax rate of the company. If you want to be a bit conservative, you may want to use the corporate tax rate if you think that the effective tax rate of the firm isn't a good example of the long run tax rate that it will face. Now, we have got to go from just as we did in the operating cash flow from net income, or in our case, unlevered net income to cash flows. So we're going to add back the depreciation and amortization which is listed in the cash flow from operations. We're going to add back the increase, decrease in the operating working capital, and we're going to add back the capital expenditure. We're not going to take dividends because we want to know the total amount of cash that is freely available to service both debt and equity holders. Now, in a highly leveraged structure, all the cash is going to be used to service debt holders and that's one of the reasons why you'll sometimes see at the bottom cash flows available to service debt holders, which we have in this case. And I'm going to do a sum and that sum is going to be the capital expenditure, the change in the operating working capital, the depreciation and amortization and the unlevered net income, which I'm calling NOPAT. So then I can then copy this across all the way to year eight and that will give me my total free cash flows. So the free cash flows available to service debt is 434. Compare that to the net cash flow on the accounting cash flow statement. And the difference is the financing cash flow that is containing the dividends and also the fact that the net income had been affected by the interest expense. So our free cash flows is just the cash flow statement recast, assuming that there's no debt, no interest, no debt repayment, no stock issuance, no stock repurchases, and no dividends. And that cash flow is the cash flow generated by the operational business.