Identify the five uses of free cash flow and how these uses are related to a financial plan.

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Identify the five uses of free cash flow and how these uses are related to a financial plan.

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Identify the five uses of free cash flow and how these uses are related to a financial plan.

Explanation & AnswerSolution by a verified expert

Explanation

The uses of the free cash flow includes:

Payment of dividends- Free cash flow is used to pay dividends to the shareholders after deducting interest and debt obligations.
To repurchase stock- Free cash flow is used to buy the stock of the company from the open market to keep it in treasury. It is done because the cash flows can be seen as a positive sign which will eventually help in increasing the market value of equity.
Payment of net after-tax interest on debt- Free cash flow is used to pay interest on a company's borrowings.
Repayment of borrowings- Free cash flow is used to pay off the loans as they come due.
Funds available to invest in financial assets- Free cash flow enables a firm to invest in financial assets to make additional earnings and returns.

 
Free cash flows gives the total availability of the funds to meet the dividend liability. Thus, a company can frame its dividend policy. Moreover, the company can determine the optimum capital structure when the amount of free cash flows is known. Depending upon the quantum of free cash flows, the management can determine proportion between reinvestment and external financing.
 
Depending upon the nature of free cash flows, the corporation can determine its utilisation. If the cash flows are positive, the company can plan out the amount to be distributed among the shareholders and amount to be reinvested in the business. On the contrary, if the cash flows are negative, the company can plan out the need and source of additional capital requirement.

Verified Answer

Uses of free cash flow are:

Payment of dividends
To repurchase stock
Payment of net after-tax interest on debt
Repayment of borrowings
Funds available to invest in financial assets

 
These different uses of free cash flow helps a firm to determine how much cash is to be kept invested in the firm for future needs and how much to be paid to the stakeholders in the form of interest and dividends.

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