After several attempts trying to understand the formulas of Initial Outlay and terminal year non-operating cash flow, I’m still confused over how the formulas are presented.
With regard to the former concept, the formula is expressed as followed:
Outlay = FCInv + NWCInv – Sal0 + T (Sal0 – B0)
While according to my logic, it should be Outlay = FCInv + NWCInv(new project) – NWCInv(old project) – Sal0 + T (Sal0 – B0)
The rationale behind my formula is Outlay of new investment is = FCInv + NWCInv(new project) - Terminal year after-tax non-operating cash flows of previous project.
As for the second formula TNOCF = (SalTNew – SalTOld) + NWCInv – T[(SalTNew – BTNew) – (SalTOld – BTOld)], I believe it should be expressed as followed:
I think you are confusing the term Net Working Capital itself with other kind of variations that in sum are the same. The questions will always give you the calculated value of “NWCInv(new project) – NWCInv(old project) = NWCINv” as data, unless otherwise stated.
Be careful with this approach because you may make a mistake somewhere. The idea of initial outlay is to assess the investment necessary to run a certain project. This very case about a replacement of an old machinery is one of the most common cases, so a good example for understanding concepts about capital budgeting.
Outlay = FCInv + NWCInv – Sal0 + T (Sal0 – B0)
The formula above is correct and much simple than you think. When you replace a machine you must buy the new one and pay all other costs related to the installation or proper run; also invest in additional WC or in other case save some WC (which is good), also sell the old machine at some point in time (most likely at time 0, because we are replacing it).
The sale of the old machine will presume a gain or loss in accounting terms. If you bear a gain, you will pay higher taxes (marginally), otherwise, you will save taxes (this is in the assumption the project is a portion of bigger entity/company that has other projects). This part of the formula “– Sal0 + T (Sal0 – B0)” covers this properly.
This formula looks like you are selling the old machine at time T (end year of new project). Are you sure this is accurate?
The correct formula for TNOCF should be = SalTNew + WC - (SalTNew – BTNew)*Tax (…why consider the old machine here)
I think you should post the question and story to udnerstand the context of your conclusions.