I am getting confused over something. When calculating the capital project various items (Initial outlay, CFs, terminal Cash flows) I am getting confused on something.
I am comfortable setting up the initial cash outflow. and the operating cash flows during the time period (say 5 years)
In the 5th and final year, I was under the impression that your terminal CF is the operating CF for that yeaR + WC + Sale of machinery? Therefore your TCF is slightly higher then on the calculator you do the normal CF01 02 03 calc function for NPV.
With this in mind, I am very confused over a question 1 in the CFA EOC question on capital budgeting.
The initial outlay is -533k. The CFs are 146k. However the fifth and final terminal cash flow they have IGNORED the cashflow during the year and just taken the WC + Sale price.
I thought the T5 would be 146k (operating cf after tax) + WC + Sales Price =304k
Check again and look well, the present value of cash flows 1 to 5 are already counted in the summatory. They put apart the present value of the terminal value of 124,000.
You can calculate the present value of 146k from year 1 to 4 plus then present value of CF5 + TV, or do it as the book did.
Sorry not sure I am following your explanation. Can you please elaborate?
They didn’t ignore nothing, they just calculated the present value of CF1 to CF5 in a single summatory. Check the numbers in Σ, it says 1 to 5, so there are the five 146k cash flows.
They separated the liquidation cash flow (124k) and correctly discounted it to year 0.
Don’t confuse terminal value with liquidation value or with “last” cash flow. In this case, the project has a known finite life (it is not a going concern), so here we have a liquidation value (124k). Operating cash flows (146k) are generated from the use of the machine; therefore the last year you have the 5th operating cash flow 146k and the liquidation value of the machine 124k.
Hope this helps.
Oh of course. Thanks Harrogath. My brain is fried.