Financial Management: Principles and Applications, 13/e

12.2 Forecasting Project Cash Flows

To analyze an investment and determine whether it adds value to the firm, following Principle 3: Cash Flows Are the Source of Value, we use the project’s free cash flow. Free cash flow is the total amount of cash available for distribution to the creditors who have loaned money to finance the project and to the owners who have invested in the equity of the project. In practice, this cash flow information is compiled from pro forma financial statements. Pro forma financial statements are forecasts of future financial statements. We can calculate free cash flow using Equation (12–2) as follows:

$$\begin{array}{c}\begin{array}{c}\text{Free}\text{Cash}\\ \text{Flow}\end{array}\end{array}$$