Week 8 Forcasting Cash Flows

Forecasting the Cash Flows

Let’s revisit our old friends at Amalgamated Hat Rack. Suppose that Amalgamated is considering buying a new piece of machinery, a smart-technology, high-temperature plastic extruder costing $100,000. If purchased and put into operation the cost savings as a result of using the new machine are estimated to be $18,000 a year for the life of the machine, which is seven years. Given these inputs, the cash flow forecast for the Plastic Extruder project looks like this:

In this case developing the forecast for the incremental cash flows associated with the project was fairly straightforward. Experts have informed us that the machine will cost $100,000 and the cost savings from putting it into use will be $18,000 a year for seven years.

Don’t be misled into thinking that all cash flow forecasts are this easy, however. Most of the time they are much more difficult. For comparison, check the cash flow forecast on page 290 of your M: Finance text. Note that this forecast would be considered fairly simple in the real business world (typical forecasts out in the world can be hundreds of rows long and extend across multiple “tabs” in a spreadsheet).

Regardless of whether the cash flow forecast is short and simple or long and hard, however, the objective is the same: to produce a series of net cash flows for each period in the analysis. In our plastic extruder example the net cash flows are an initial $100,000 cash outflow followed by seven $18,000 cash inflows. 

Once you are in possession of the all-important set of net cash flows, you cash flow forecast is complete.  Cash flow estimation can be very involved and is beyond the scope of this course.  We will utilize simple CF forecasts.