Capital Budgeting

Ths pertains to the Capital Budgeting Topic

TNOCF = ( Sale Tnew-Sal T old) +NWC inv -T( Sale Tnew- B Tnew)- (Sale Told-B Told)

Why does TNOCF( Replaceent project) include a deduction for the after tax sale value of the replaced asset when we already deduct the sale value in the initial outlay ?

I was confused about this as well but thinking about it in this way really helped.

For replacement projects, we look closely at the incremental cash flow or the cash flow that is realized because of a decision: the cash flow with a decision minus the cash flow without that decision. (CFAI p. 8)

We want to use this equation only when the useful life of both the new and old asset end in the same year. There’s an example in the reading that may provide a more concise explanation (CFAI p. 35)

I still dont understand

Let’s start over. First, try looking at this problem as two separate scenarios. For Scenario A, we sell the old equipment and buy the new equipment. In Scenario B, we continue to use the old equipment and do not buy the new equipment.

CF in Scenario A - CF in Scenario B = Incremental CF

In TNOCF, the sale of the old equipment and taxed gain is included again because that cash flow occurs under Scenario B. It may seem like it was already taxed in the initial outlay but that’s the cash flow under Scenario A.

Assuming you already understand how to calculate operating cash flows, it’s simply the same process.