SOURCE: Andre Jenny/Unicorn Stock Photos
CHAPTER
Cash Flow Estimati on
and Risk Analysis
46
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through the Internet. Third, new stores could
“cannibalize,” that is, take sales away from, existing
stores. This last point was made in the July 16, 1999,
issue of Value Line:
The retailer has picked the “low-hanging fruit;” it
has already entered the most attractive markets. To
avoid “cannibalization” — which occurs when
duplicative stores are located too closely together —
the company is developing complementary formats.
For example, Home Depot is beginning to roll out its
Expo Design Center chain, which offers one-stop sales
and service for kitchen and bath and other
remodeling and renovation work . . .
The decision to expand requires a detailed
assessment of the forecasted cash flows, including the
risk that the forecasted level of sales might not be
realized. In this chapter, we describe techniques for
estimating a project’s cash flows and their associated
risk. Companies such as Home Depot use these
techniques on a regular basis to evaluate capital
budgeting decisions.
ome Depot Inc. has grown phenomenally over the
past decade, and it shows no sign of slowing
down. At the beginning of 1990, it had 118
stores, and its annual sales were $2.8 billion. By early
2001, it had more than 1,000 stores, and its annual
sales were in excess of $45 billion. Despite concerns of
a slowing economy, the company expects to open
another 200 stores in fiscal 2001.
Home Depot recently estimated that it costs, on
average, $16 million to purchase land, construct a new
store, and stock it with inventory. (The inventory costs
about $5 million, but about $2 million of this is
financed through accounts payable.) Each new store
thus represents a major capital expenditure, so the
company must use capital budgeting techniques to
determine if a potential store’s expected cash flows are
sufficient to cover its costs.
Home Depot uses information from its existing stores
to forecast new stores’ expected cash flows. Thus far, its
forecasts hav