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