Question

How can FCF in the terminal year of a project’s life differ from FCF in the other years? Provide an example.

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Answer 1

Free cash flows of a terminal year in the project life will be different because free cash flows will generally include the terminal value or salvage value and hence the overall cash flows in the last year of a project will always be higher because there will be a terminal value associated with it.

For example, if we have purchased a plant and we are estimating the the cash flows from each year then we are calculating that it will generate at $10,000 per year for ten years but in the tenth year the salvage value will be realised of the plant of $50,000 which is representative of when the asset will be disposed off, and salvage value or terminal value will be realised and hence the free cash flows in the last year will be higher than other cash flows.