Question

xyz company is considering whether a project requiring the purchase of new equipment is worth investing. the cost of a new machine is $340,000 including shipping and installation. the project will increase annual revenues by $400,000 and annual costs by $100,000. the machine will be depreciated via straight-line depreciation for three years to a salvage value of $40,000. if the firm does this project, $30,000 in net working capital will be required, which will be fully recaptured at the end of the project. the estimated salvage value of the machine after the project is $30,000. what is the terminal value of this project if the tax rate is 40%? round to the nearest penny. do not include a dollar sign in your answer.

Answer 1

The terminal value of XYZ Company's project is determined by accounting for the salvage value of the equipment, the recaptured net working capital, and the tax benefits due to depreciation and potential loss on sale of the equipment.

Step-by-step explanation:

To calculate the terminal value of XYZ Company's project with the new equipment, we need to account for the terminal cash flows including the salvage value, recaptured net working capital, and the tax implications. The annual depreciation expense is calculated by dividing the depreciable base ($340,000 cost - $40,000 salvage value) by the life of the asset, which results in $100,000 per year.

After three years, the total depreciation will be the full depreciable base of $300,000. The book value at the end of year 3 will be the initial cost minus accumulated depreciation, resulting in a book value of $40,000. The actual salvage value is $30,000, leading to a loss on sale of $10,000, which generates a tax shield (benefit) at a 40% tax rate, equal to $4,000. Additionally, the $30,000 in net working capital is recaptured tax-free.