Beckham Broadcasting Company (BBC) has operating income (EBIT) of $2,500,000. The company's depreciation expense is $500,000 and it has no amortization expense. The company is 100% equity financed. The company has a 40% tax rate, and its net investment in operating capital is $1,000,000.

What is BBC's free cash flow?

a. $0

b. $500,000

c. $900,000

d. $1,000,000

e. $1,500,000

The correct answer is option (D).

Explanation:

According to the scenario, the given data are as follows:

Operating Income (EBIT) = $2,500,000

Depreciation Expense = $500,000

Tax rate = 40%

Net investment = $1,000,000

So, we can calculate the BBC's free cash flow by using following formula:

= EBIT * (1 - Tax Rate) + Depreciation & Amortization - Net investment

Now put these values to the above formula

So, the value would equal to

= $2,500,000 * (1 - 40%) + $500,000 - $1,000,000

= $1,500,000 + $500,000 - $1,000,000

= $1,000,000