Terminal year cash flows- Replacement Project

Schweser Practice Exams Vol 2. (2011), exam 2 afternoon session, corporate finance: q85

While calculating the sale of equipment at terminal year, they are using incremental Salvage value… The existing equipment will be sold at year 0, and new equipment will be sold at the end of year 3…

I just checked Schweser notes and the formula uses salvage value of new equipment not the incremental salvage value…

Sale Value + NWCInv - t (Sale Value - Book Value)

Please clarify…


Although the formula doesn’t explicitly say it, it is supposed to be the incrementl sales.

(sale of new - sale of old) + nwcinv - t [(sale of new - sale of old ) - (bv of new - bv of old)]

The CFAI text uses the same formula you mentioned, but solves it incrementally.

I like this method of reasoning:

If you do not replace you end up with:

TV = 90 - 0.4*(90 - 0) = 54

If you do not replace but simply buy another machine you end up with:

TV = 130 - 0.4(130 - 0 ) = 78

So if you replace:

78 - 54 = 13.8

CFAI blue box presents nice example.

Try to understand the concept not simpy equations.

I hope this was your point.

Thanks … that clarifies my doubt and understood the reasoning as well… :slight_smile:

If I am not wrong, you will only use incremental salavge in terminal year if the current equipment is able to last till that year.

If the current equipment will be sold immediately upon the purchase of new equipment, terminal year does not include the incremental salvage thingy.