book 7, exam 2 afternoon session, corporate finance: q85 when calculate the sale of equipment at terminal year, why use the difference of expected salvage value from existing equipment and Tera Project? the existing equipment will be sold at year 0, and Tera project equipment will be sold at the end of year 3, isn’t it? I thought it should use difference between the salvage value of tera project equipment and the book value (after adjusted for depreciation)… any thought on this ? Thanks.
I don’t have access to this question, but: In a replacement project you are looking for the incremental cash flows for the project. Therefore, when calculating TNOCF you would take the difference in salvage values, add back the WC investment, and take the difference in salvage values - book values and multiply that by the tax rate.
that makes sense. Whatever you have book value, you pay taxes on that. But when you sell your equipment for greater than book value, you create additional tax liability, which is teh difference between teh salvage value - book value. To clarify: If you sold your $10 book value stuff for $15, your cash has gone up by $15, but your assets have only gone down by 10 as its not longer with you. But you must pay taxes on any gains due to sale of asset in the year the asset is sold. you don’t have to pay taxes on entire $15 received, cuz since the day you’ve bought that asset you’ve been depreciating it and paying taxes. Net net you only have to pay taxes on $5 cuz thats your windfall. If infact lets say salvage value was 0, but book value was $10. and you hit the terminal year, then during your TNOCF would actually go up by $10 less the taxes you pay on that $10, because of the -ve sign.
"and take the difference in salvage values - book values " you refer to the salvage value and book value of the equipment for the new project which is under consideration? correct me if I am wrong. should book value be adjusted by depreciation? thanks. say at time 0, purchase the equipment for the new project by 1 million, project last 5 years with MACRS 7 year depreciation, at the end of year 5, the book value will be 1 million - all depreciations from year 1-5? thanks bpdulog Wrote: ------------------------------------------------------- > I don’t have access to this question, but: > > In a replacement project you are looking for the > incremental cash flows for the project. Therefore, > when calculating TNOCF you would take the > difference in salvage values, add back the WC > investment, and take the difference in salvage > values - book values and multiply that by the tax > rate.
Salvage value of replaced equipment comes in as a project inflow. (initial). salvage value of the “replacer” equipment is a project inflow at the end of the project.
cpk, salvage value of the replacer is a project outflow you mean?
At the beginning -Initial Outlay + Salvage value of Replaced equipment(1-T) - NWC At the End Final Terminal Outflow + Salvage value Replacer equipment (1-T) + NWC