Question

Your company is considering the purchase of a new machine. After 4 years of operation, you would sell the machine for a salvage value of $46001. However, at that time the machine would not have been depreciated to a value of 0, but have a remnant book value of $19746. The operation of the machine requires additional NOWC of $31636, which would not change throughout the project. The firm's corporate tax rate is 40%. What is the project's Terminal Cash Flow?

Answer 1

Salvage value in excess of book value of machine should be taxed.

Tax on salvage value = (Salvage value – Book value) × tax rate

                                    = (46,001 – 19,746) × 0.40

                                    = 26,255 × 0.40

                                    = $10,502

After-tax salvage value = Salvage value – Tax on salvage value

                                    = 46,001 – 10,502

                                    = $35,499

NOWC should be recovered at the end of the project and it is tax-free.

Terminal cash flow = After-tax salvage value + NOWC

                                = 35,499 + 31,636

                                = $67,135 (Answer)