CHAPTER 4
Forecasting Cash Flows
Intheprecedingchapter,wefocusedonthequestionofhow
best tomeasurecash flows.Inthischapter, weturnto the
more difficult question of how best to estimate expected
futurecash flows. Webeginby lookingat thepractice of
usinghistoricalgrowthratestoforecastfuturecashflowsand
thenlookattheequallycommonapproachofusingestimates
of growth either supplied by management or from other
analysts tracking the company. As a final variation, we
describeamoreconsistentwayoftyinggrowthtoafirm’s
investment and financing policies.
Inthesecondpartofthechapter,weexaminedifferentways
ofbringing closuretovaluation byestimatingthe terminal
value and how to keep this number from becoming
unbounded.Inparticular,welookattheconnectionbetween
terminalgrowth andreinvestment assumptions.In thefinal
sectionofthechapter,weconsiderthreevariationsoncash
flowforecasting:expectedvalueestimates,scenarioanalysis,
and simulations.
STRUCTURE OF DISCOUNTED CASH FLOW
VALUATION
Tovalueanasset,wehavetoforecasttheexpectedcashflows
over its life. This can become a problem when valuing a
publicly traded firm, which at least in theory canhave a
perpetual life. Indiscounted cash flow (DCF) models, we
usuallyresolvethisproblembyestimatingcashflowsfora