You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the terminal cash flow for this project?

Question

Quizplus · Accepted Answer

The terminal cash flow includes the after-tax salvage value, recovery of net working capital, and any remaining depreciation tax shield. The after-tax salvage value is $28,000 - ($28,000 - $40,000) * 0.35 = $24,500. The recovery of net working capital is $4,000. The remaining depreciation tax shield is $0 because the equipment is fully depreciated over six years. Therefore, the terminal cash flow is $24,500 + $4,000 = $28,500. However, the correct calculation should include the tax shield from the remaining book value, leading to the correct terminal cash flow of $37,950.

You Are Analyzing the Purchase of New Equipment