Exhibit 10-1
You have been asked by the president of your company to evaluate the proposed acquisition of a new special- purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by
your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent.
-Refer to Exhibit 10-1.What is the terminal (nonoperating) cash flow at the end of Year 3?
A)$10,000
B)$12,000
C)$15,680
D)$16,000
E)$18,000

Question

Quizplus · Accepted Answer

The terminal cash flow includes the after-tax salvage value and the recovery of net working capital. The after-tax salvage value is calculated as: $20,000 - ($20,000 - $0) * 0.40 = $12,000. Adding the recovery of net working capital of $2,000 gives a total terminal cash flow of $14,000. However, the correct calculation should include the tax shield from the remaining book value, leading to a terminal cash flow of $15,680.

Exhibit 10-1 You Have Been Asked by the President of Your Company