Planning Capital Expenditure 297Putting the Pieces Together to
Forecast Cash Flow
We now have all the puzzle pieces to construct our capital budgeting cash-f low
projection. These pieces and the resulting cash-f low projection are presented
in Exhibit 10.3. Cash f lows in years 1 through 9 are forecast to be $2.42 mil-
lion, and the cash f low in year 10 is expected to be $5.32 million. Year 10 has a
greater cash f low because of the recovery of the inventory and the assumed
sale of the land and plant.
GUIDING PRINCIPLES FOR
FORECASTING CASH FLOWS
The brewery example is one illustration of how cash flows are forecast. Every
project is different, however, and the financial analyst must be keen to identify
all sources of cash f low. The following three principles can serve as a guide:
(1) Focus on cash f low, not on raw accounting data, (2) use expected values,
and (3) focus on the incremental.
Principle No. 1: Focus on Cash Flow
NPV analysis focuses on cash flows—that is, actual cash payments and receipts
f lowing into or out of the firm. Recall that accounting profit is not the same
thing as cash f low. Accounting profit often mixes variables whose timings dif-
fer. A sale made today may show up in today’s profits, but since the cash re-
ceipt for the sale may be deferred, the corresponding cash f low takes place
EXHIBIT 10.3 Cash f low projections for brewery project
(thousands).
Year: 0 1–9 10
Construction $(8,000)
Land (1,000) $1,000
Inventory (1,000) 1,000
Account receivable (400) 400
Accounts payable 400 (400)
Sales $7,000 7,000
Cost of goods sold (2,000) (2,000)
Selling, admin., and general (1,000) (1,000)
Advertising (500) (500)
Income tax (1,080) (1,080)
Salvage 1,500
Windfall tax (600)
Total cash f low $(10,000) $2,420 $5,320