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Chapter 4. Cash is King: Estimating Cash Flows

Chapter 4. Cash is King: Estimating Cash Flows

The value of an asset comes from its capacity to generate cash flows. When valuing a firm, these cash flows should be estimated after taxes, prior to debt payments, and after reinvestment needs. There are thus three basic steps to estimating these cash flows. The first is to estimate the operating income generated by a firm on its existing assets and investments. Although you can obtain an estimate of this from the income statement, you must substantially adjust the accounting income for technology firms to yield a true operating income. The second step is to estimate the portion of this operating income that would go toward taxes. In this chapter, we investigate the difference between effective and marginal taxes at this stage, as well as the effects of substantial net operating losses carried forward. The third step is to develop a measure of how much a firm is reinvesting for future growth. While this reinvestment will be divided into reinvestment in tangible and long-lived assets (net capital expenditures) and short-term assets (working capital), we will again use a much broader definition of reinvestment to include investments in R&D and acquisitions as part of capital expenditures.


  

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