Introduction to Finance: Markets, Investments, and Financial Management, Fourteenth Edition

Chapter LE17. LEARNING EXTENSION 17: ESTIMATING PROJECT CASH FLOWS

How are cash flow estimates developed? In this section we present a practical overview of how an analyst develops the data to estimate cash flows.

PROJECT STAGES AND CASH FLOW ESTIMATION

A typical project encompasses three stages. First there is the initial outlay or investment. Second is the operating life of the project, be it market expansion, a building, or technology. The final stage is at the end of the project's useful life. For projects involving fixed assets or business lines, this can involve selling assets and reclaiming working capital. But for projects that have an indefinite life—such as business expansion—a few years of careful cash flow estimations may give way in the third stage to an estimate of terminal value—that is, what the present value of project cash flows might be far into the future. We'll examine each of the three stages below.

INITIAL OUTLAY

The first cash flow estimate is the initial investment in the project. Engineering estimates may be available for projects that require designing or modifying equipment and buildings. Engineers will examine preliminary designs or architectural sketches and estimate the quantities of various materials needed. Estimates of purchases, transportation costs, and construction expenses can be developed based on current market prices.

Another means of estimating the acquisition or construction cost of a project is to solicit bids from various construction or equipment ...