Question

ABC Co. requires a 15% rate of return on its capital, and the firm is in the 35% marginal tax bracket. The company is considering a new project that involves the introduction of a new product. This project has a 5 year life; afterwards the product will cease to exist. Given the following information: Cost of new plant and equipment: 7,250,000 Unit sales: 80,000 (year 1), 110,000 (year 2), 110,000 (year 3), 80,000 (year 4), 60,000 (year 5) Price per unit: $230 Variable costs per unit: $140 Fixed costs: $500,000 per year Depreciation method: Straight line method over 5 years. Assume that the plant and equipment will have a salvage (market) value of $750,000 at the end of year 5. Working capital requirements: there will be an initial working capital requirement of $500,000 at the start of the project. At the end of the second year of the project, the firm will need an additional $250,000 working capital injection. Finally, all working capital is liquidated at the termination of the project at the end of year 5. Calculate the terminal cash flow for the project.

Answer 1

I have calculated the NPV.

Terminal cash flow is the final net inflows and outflows of a project or investment after disposing of necessary equipment and paying all expenses and taxes. In other words, it’s the final amount of money a company will be left with after a project is terminated, the equipment is disposed of, the working capital is recouped, and all expenses and taxes are paid.

Hence in this case Terminal Cash Flow = After tax proceeds from Salavage value + Recovery of Working Capital

Terminal Cash Flow = $750,000 + $500,000 + $250,000

= $1,500,000

In this case salvage value and book value is same and so there is no Tax and hence $750,000 will be after tax proceeds from salvage value. Both the Working capital recovered as per the sum and hence both included.

Also, we calculate the PV of terminal cash flow = $1,500,000 * PVif(15%,5year) i.e. $1,500,000 * 0.4972 i.e $745,765.10.