Question

ABC Corporation has hired you to evaluate a new FOUR year project for the firm. The project will require the purchase of a $835,200.00 work cell. Further, it will cost the firm $53,700.00 to get the work cell delivered and installed. The work cell will be straight-line depreciated to zero with a 20-year useful life. The project will require new employees to be trained at a cost of $64,800.00. The project will also use a piece of equipment the firm already owns. The equipment has been fully depreciated, but has a market value of $7,100.00. Finally, the firm will invest $11,400.00 in net working capital to ensure the project has sufficient resources to be successful. The project will generate annual sales of $906,000.00 with expenses estimated at 39.00% of sales. Net working capital will be held constant throughout the project. The tax rate is 39.00%. The work cell is estimated to have a market value of $458,000.00 at the end of the fourth year. The firm expects to reclaim 80.00% of the final NWC position. The cost of capital is 14.00%.

What is the terminal cash flow for the project?

Answer 1

Terminal cash Flow is the net cash flow that occurs at the end of the project and it includes after-tax cash flow from disposing of the equipment and recovery of working capital.

Terminal Cash Flow is calculated as = Post tax proceeds from disposal of Equipment/ Machinery + Recovery of Working Capital

a) Fixed and one time cost associated with buying the work cell are as follow :

Initial purchase cost = $835,200

­Installation Cost = $53,700

Total Capitalised Cost to work cell   = Initial purchase cost + Cost of Training + Installation Cost                                                                                     =835,200 + 53,700

= $888,900

b) Annual Depreciation = (Total Capitalised Cost)/ No of Years – Salvage Value
                                      = (888,900)/20 – 0
                                      = $44,445

Book Value after 4 years = Total Capitalised Cost – (Annual Depreciation * 4 Years)

                                            = 888,900 * (44,445 * 4)

                                            = 888,900 – 177,780

                                            = $711,120

Market Value of work cell after 4 years = $458,000
Loss on sale of work cell = Book Value – Market value at the end of 4th year
                                           = $711,120 - $458,000
                                           = $253,120

Tax saving on loss on sale of work sell = Loss on sale * Tax Rate
                                                                    = $253,120*0.39
                                                                   = $98716.8
Post Tax Salvage Value = Market Value/ Realisation price + Tax saving on loss on sale of work cell

                                         = $458,000 + $98,716.8

                                         = $556,716.80

Note : We assume the old equipment used will have a market value 0 at the end of Year 4 and hence have not been made part of our calculations.

c) Recovery of working capital
Net working capital = $11,400

Recovery Rate is 80%

Recovery of working capital at end of Year 4 = Net Working Capital * Recovery Rate
                                                                                = $11,400 * 80%
                                                                                = $9,120

d) Terminal Cash Flow in Year 4

Terminal Cash Flow in Year 4 = Post Tax Salvage Value of Work Cell + Recovery of Working Capital
                                                      = $556,716.80 + $9,120
                                                      = $565,836.80