Certified Valuation Analyst (CVA) Practice Exam

What must be subtracted from EBITDA to calculate net cash flow to invested capital?

1. Taxes

2. Depreciation

3. Capital expenditures

4. Interest expenses

The correct answer is: Capital expenditures

To determine net cash flow to invested capital, it is essential to recognize what constitutes this flow. EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, represents a company's operational performance without considering capital structure and non-cash expenses. Capital expenditures (often abbreviated as CapEx) refer to funds that a company invests in acquiring or upgrading physical assets such as property, industrial buildings, or equipment. These expenditures are vital to sustaining and growing the operational capacity of a business. When calculating net cash flow, it's necessary to account for values that genuinely reflect the cash available for reinvestment and distributions after necessary investments in the company's operational ability. By subtracting capital expenditures from EBITDA, one arrives at a more accurate picture of the cash flow available for distribution to investors. This adjustment reflects the reality that cash utilized in capital expenditures is not available for dividends, debt repayment, or reinvestment in the business. In contrast, while taxes, depreciation, and interest expenses can impact cash flow, they do not directly determine the cash available after necessary investments in the business, which is why capital expenditures are the critical factor in this calculation.