We calculate free cash flows to the firm for historical and current years. We will be using these historical free cash flows as estimates of future free cash flows.

Answer the following:

1. What are the threats to the validity of our models when we rely on historical cash flows to help us predict future cash flows?

2. Is it better to base our estimate of future cash flows off of the most recent year or an average of past several years, for example, five years?

Answer rating: 100% (QA)

There are several threats to the validity of using historical cash flows to predict future cash flows including Changes in market conditions Market conditions and economic circumstances can change significantly over time affecting a companys ability to generate cash flows Historical cash flows may not be an accurate predictor of future performance if these conditions change significantly Changes in the company A company may change over time due to factors such as mergers acquisitions or changes in management which can impact its ability to generate cash flows Historical cash flows may not be an accurate predictor of future performance if these changes have a significant impact Onetime events Historical cash flows can be influenced by onetime events such as major capital expenditures legal settlements or other nonrecurring items that are unlikely to occur in the future These events may skew the historical cash flows and make them a poor predictor of future performance Inflation Historical cash flows may not be adjusted for inflation which can impact their relevance to predicting future cash flows Whether it is better to base future cash flow ... View the full answer