In: Finance
Green Zebra wants to test out alternative energy for its facilities. It is considering an investment in a new wind-energy tower with a price of $7million to replace its existing natural gas furnace. Today, the current machine has a book value of $4million and could be sold for $3.5 million. The new machine is expected to have three year life, and the old machine has three years remaining in its economic life. Both machines use straight line depreciation to a zero value at the end of the assets life. If the firm replaces the old machine with the new machine, it expects to save $5.5 million in operating costs before depreciation each year over the next three years. The old furnace will be worth $500,000 at the end of the project life. If the firm purchases the new wind machine, it will also need an investment of $150,000 in net working capital. The required return on the investment is 7 percent, and the tax rate is 25 percent. What is the terminal value associated with the project in T3?
Green Zebra | |||||
Cash flow details for replacement of NG Furnace | All Amt in $ | ||||
Particulars | Year 0 | Year 1 | Year 2 | Year 3 | |
Initial Investent | |||||
New Machine | (7,000,000) | ||||
Less sales value of old m/c | 3,500,000 | ||||
Investment in NWC | (150,000) | ||||
a | Total Initial Investment | (3,650,000) | |||
Operating Cash flow | |||||
Operating Cost saving pre depreciation | 5,500,000 | 5,500,000 | 5,500,000 | ||
Depreciation on New Machine | 2,333,333 | 2,333,333 | 2,333,333 | ||
Depreciation on old macine | 1,333,333 | 1,333,333 | 1,333,333 | ||
Incremental Depreciation | 1,000,000 | 1,000,000 | 1,000,000 | ||
Net Cost Savings after depreciation | 4,500,000 | 4,500,000 | 4,500,000 | ||
Incremental Tax on savings @25% | 1,125,000 | 1,125,000 | 1,125,000 | ||
Incremental Income post tax | 3,375,000 | 3,375,000 | 3,375,000 | ||
Incremental Depreciation added back | 1,000,000 | 1,000,000 | 1,000,000 | ||
b | Operating cash flow | 4,375,000 | 4,375,000 | 4,375,000 | |
Terminal Cash flow | |||||
Net working capital Returned | 150,000 | ||||
Post Tax opportunity loss on salvage value of old machine =500,000*(1-25%) | (375,000) | ||||
c | Terminal Value | (225,000) | |||
d | Total Cash flow =a+b+c | (3,650,000) | 4,375,000 | 4,375,000 | 4,150,000 |
So Terminal Value at Yr 3= | (225,000) | ||||
Terminal Cash flow at Yr 3= | 4,150,000 |