Question

Which of the following cash flows are not considered in the calculation of the terminal cash-flow for a capital investment proposal?

Tax effect on Capital Loss/Gain

Book value of the asset

cost of issuing new bonds to finance the new project.

net working capital.

Salvage price of the asset

And please explain as well

Answer 1

Bifurcated the cash flows into two parts for better understanding as to which cash flows will NOT be considered for calculating terminal cash flow for a capital investment proposal

Cash Flow Considered	Cash Flow NOT considered
Tax effect on Capital loss/gain	Cost of issuing new bonds to finance the new project
Book value of asset	Net working capital*
Salvage price of the asset

Reason

In order to calculate adjusted salvage vale of an asset we use the following formula in case of profit

Salvage Value - Profit on sale * Tax rate

And, Profit on sale = Salvage value - closing WDV

In order to calculate adjusted salvage vale of an asset we use the following formula in case of loss

Salvage Value + Loss on Sale * Tax rate

And, Loss on sale = Closing WDV - Salvage Price

And, Closing WDV = Original Cost - depreciation till date

All the items mentioned in the table as cash flow considered will be required to calculate the adjusted salvage value, which is further taken into account to calculate terminal cash flow.

Items not considered

Net working capital [increase - outflow / decrease - inflow],

Net working capital = Current assets - current liabilities

If there is any change in the working capital, this change does not impact taxes.

However, one point to be noted is that in case problem is silent, any introduction of working capital at the start is treated like an outflow and any release at the end is treated like an inflow *

Cost of issuing new bonds to finance the new project - This expense usually takes place in zero period, when we begin to start a project.