1
FIN 2004 Finance Tutorial 8:
Capital Budgeting II
Conducted by : Mr Chong Lock Kuah, CFA

Revisit some important concepts

After-tax Salvage Value
•
After-tax salvage value of the equipment if sold at a gain (i.e.
salvage value
book value of equipment at terminal year)
can be calculated as:
After-tax salvage value = salvage value
–
(salvage value
–
book
value) tax rate
•
After-tax salvage value of the equipment if sold at a loss (i.e.
salvage value
book value of equipment at terminal year) can
be calculated as:
After-tax salvage value
=
Salvage value + (book value
–
salvage value) tax rate

Cont’d
•
In general, the incremental cash flows from a typical project can be
classified as follows :
1.
Initial investment outlay
=upfront cost of fixed asset associated
with the project plus increase in net working capital, if applicable.
Sometime the question requires the increase in net working capital to
be subtracted from each year after-tax operating cash flows. (please
note when the net working capital is decreased, it means that there is
a recovery of net working capital and this decrease in net working
capital should be added to that year’s cash flow)
2.
Operating cash flows
over the project’s life (after
-tax operating
income + depreciation)
–
increase in net working capital (if
applicable)
3.
Terminal year cash
flows which include salvage value of the fixed
assets adjusted for taxes if assets are not sold at their book value
plus the return of the net working capital if applicable

5
Expansion vs. Replacement Project
•
An expansion project
is defined as one where the firm invests in
new assets to increase sales.

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- Spring '11
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