Question

Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $23031. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5525 at the inception of the project, but this amount will be recaptured at the end of year five. What is the terminal cash flow, to the nearest dollar?

Answer 1

The terminal cash flow is calculated by adding the after-tax salvage value of the new van, the after-tax salvage value of the old van, and the recaptured working capital. The result, not accounting for additional cash flows such as annual savings, is approximately $38,356.

Step-by-step explanation:

To calculate the terminal cash flow when replacing an old delivery van with a new one, we consider the salvage value of the new van, the remaining book value of the old van, the tax effects, and the recovery of working capital. We start with the salvage value of the new van at the end of year five which is $23,031.

Depreciation for the old van over 8 years is $5,000 per year ($40,000/8 years), thus after 5 years, the accumulated depreciation is $25,000, leaving a book value of $15,000 ($40,000 - $25,000). If the old van is sold today for $7,000, the company would incur a loss of $8,000 ($15,000 - $7,000), which at a tax rate of 35% would give a tax benefit of $2,800 (0.35 * $8,000). Therefore, the after-tax salvage value of the old van is $9,800 ($7,000 + $2,800).

The new van costs $86,000 (invoice price plus modifications), and it would be fully depreciated over its five-year useful life (depreciation of $17,200 per year). The terminal cash flow would then include the after-tax salvage value of the new van, the after-tax salvage value of the old van, minus the remaining book value of the new van at the end of year five, plus the recovery of the increased working capital. The remaining book value of the new van at year five is zero since it is fully depreciated. Including the recapture of working capital, the terminal cash flow would be $23,031 (salvage value of new van) + $9,800 (after-tax salvage value of the old van) + $5,525 (recovered working capital), totaling to approximately $38,356.

Please note that this calculation does not account for additional cash flows that might be involved in the overall investment decision, such as the annual cost savings from using the new van. To make a complete investment decision, all relevant cash flows should be considered.

Answer 2

$51,164

Step-by-step explanation:

The project's terminal cash flow is basically the cash flow of the project's last year.

depreciable value = $80,000 + $6,000 - $23,031 = $62,969

depreciation expense per year = $62,969 / 5 = $12,593.80 per year

net cash flow year 5 = [(savings - depreciation expense) x (1 - tax rate)] + depreciation expense + salvage value + recovery of net working capital = [($28,000 - $12,593.80) x (1 - 35%)] + $12,593.80 + $23,031 + $5,525 = $51,163.83 ≈ $51,164