Question

You are a project manager. You are estimating the cash flows of a potential project that requires an investment of $200,000, including installation cost, and $30,000 in working capital, which will be fully recaptured at the end of the project. The machine has an estimated life of six years and will be depreciated via the simplified straight-line method. The project is expected to raise the firm’s annual revenues by $330,000 and increase annual costs by $125,000. The machine you purchase for the project can be sold for $40,000 in six years. The firm has a marginal tax rate of 40%. What is the terminal value of the project?

Answer 1

Answer : Terminal Value of the project is $ 54,000

Calculation of Terminal Value of Project

Terminal Value is the Cash flow associated with closure the project at the end of its useful life. It does NOT include the differential cash flow from the final year of operations. It generally includes the cash from the disposal of the asset (including taxes) and the recapture of working capital.

Terminal Value = Recapture of Working Capital

+ Sale Value of Asset

(-) Taxes on Gain of Sale of Asset

Therefore Terminal Value = 30000 + 40000 - 16000

Terminal Value = $ 54,000

Release of Working Capital = $ 30,000

Book value = 0 (as at the end of period 6 Book value will be 0 as it will be depreciated on Straight line method.)

Sale Value = $ 40,000

Threfore Gain on Sale will be $ 40,000

Tax on Gain of Sale = 40000 * 40 % = 16,000