Free cash flows can be arrived at by using the following calculation

Operating profit before interest and tax (PBIT)

+                                              Depreciation (if included in operating costs)

-                                              Capital expenditure (investment) on non-current assets

-                                              Taxation

=                                              Operating free cash flow

Free cash flow represents the cash flow which is available to be distributed to holders of both equity and debt. Dividends and interest payments would be ignored when calculating free cash-flow.  To establish a value for a company, free cash flow must be discounted using a cost of capital.

The value of a company or its shares will increase if

• Free cash flows or dividends paid to shareholders increase
• The cost of capital or cost of equity falls

The value of a company or its shares will decrease if

• Free cash flows or dividends paid to shareholders decrease
• The cost of capital or cost of equity rises