Chartered Financial Analyst (CFA) Level 1 Practice Exam

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Prepare for the CFA Level 1 Exam with comprehensive study guides. Access multiple choice questions and detailed explanations to enhance your readiness. Start your journey to become a Certified Financial Analyst today!

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What formula calculates the free operating cash flow-to-debt?

[CFO(adjusted) - Capital expenditures] / Total Debt
FFO + interest paid / Gross interest
Common share dividends / Net income
EBIT / Average total capital

The correct answer is: [CFO(adjusted) - Capital expenditures] / Total Debt

The formula for calculating the free operating cash flow-to-debt is found in the first choice, which considers the cash flows generated from operations after accounting for necessary capital expenditures. Free operating cash flow (FOCF) is derived by adjusting cash flow from operations (CFO) to account for capital expenditures, which represent the investments needed to maintain or expand a company's asset base. By taking the adjusted CFO and subtracting capital expenditures, you obtain the free operating cash flow, reflecting the actual cash available to service debt. This free operating cash flow is then divided by total debt to assess the firm’s ability to meet its debt obligations using its operational cash flows. This ratio is particularly useful for investors and creditors, as it provides insight into the company's financial health and liquidity regarding its debt servicing capacity. Other options do not measure the specific relationship between free operating cash flow and debt. For example, the second option focuses on funds from operations plus interest paid relative to gross interest, which does not reflect free cash flow. The third option relates dividends to net income and does not discuss cash flows or debt, while the last choice involves earnings before interest and taxes divided by average total capital, which does not pertain to free cash flow calculations either.