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Post:
Forecasting Free Cash Flows
A. Cash Flows from Operations
· To forecast incremental cash flows from operations we must forecast the incremental net revenue, operating expenses, and depreciation and amortization associated with the project, as well as the firm's marginal tax rate
· When forecasting operating expenses, analysts often distinguish between variable costs and fixed costs
B. Investment Cash Flows
· We must consider two general classes of investments when calculating FCF: incremental capital expenditures and incremental additions to working capital
1. Capital Expenditures
o Capital expenditure forecasts in an NPV analysis reflect the expected level of investment during each year of the project's life.
o Capital expenditures are typically required at the beginning of a project
2. Working Capital
o Cash flow forecasts in an NPV analysis include four working capital items: 1)cash and cash equivalents, 2) accounts receivable, 3) inventories, and 4) accounts payable
Special Cases
A. Projects with Different Lives
A problem that arises quite often in capital budgeting involves choosing between two mutually exclusive investments where the investments have different lives.
o In a situation like this, we can effectively make the lives of the mowers the same by assuming repeated investments over some identical period and then comparing the NPVs of their costs.
Reference:
The Nature of Financial Statements: The Cash Flow Statement". Financial Analysis - Tools and Techniques - A Guide for Managers.
Bodie, Zane; Alex Kane; Alan J. Marcus (2004). Essentials of Investments, 5th ed. McGraw-Hill Irwin. p. 455. ISBN 0-07-251077-3.