In this paper, to propose two ways in which free cash flow uncertainty could be avoided rests on the assumption that a business is evaluated capital projects whose inflows and outflows are denominated in any foreign currency. In such a case, one way to reduce uncertainty about cash flow stream is to hedge against the currency risk because foreign exchange market is so volatile that large fluctuations in currencies are witnessed every minute .
Uncertainties which are inherent in projecting revenue and underlying costs and the vulnerability of the FOREX (foreign exchange) market as well as related derivatives, all of these factors contribute to concerns about the usefulness of a hedging activity. Yet a well-designed free cash flow hedging program is worthy of time and effort to be invested in. in this regard, one way is to employ a risk management program that minimizes uncertainty related to cash flow stream.
Depending upon the time value of money, future cash flows involved in every capital project are discounted by required rate of return for a specific project to compare the performance of a project considering different risk situations. Another way to reduce cash flow uncertainty in capital budgeting is to reduce the future cash flow stream by anticipated loss percentage. Such an adjustment should be used if a financial manager believes there is a risk that future payments or inflows may not be received. To perform such a calculation, one should each stream of future cash flow by ninety percent in case if a financial manager believes that the business may not be able to receive the remaining ten percent of payments related to a capital project .
Works Cited
Rodeck, David. How to Adjust for Risk in Capital Budgeting. n.d. 13 December 2014 <http://smallbusiness.chron.com/adjust-risk-capital-budgeting-10326.html>.
Stafford, Paul. Cash Flow Hedging Best Practices. 28 January 2014. 13 December 2014 <http://www.treasuryandrisk.com/2014/01/28/cash-flow-hedging-best-practices>.
