Question

Victoria Energy are considering replacing their existing machinery with new, more efficient equipment. The old machinery was purchased 4 years ago for $15,000,000 and had an estimated useful life of 6 years; it can be sold today for $6,000,000. The new machine will cost $17,500,000 but will have a 10 year life and scrap value at the end of the 10 years of $4,000,000. The new machine will require shipping and installation costs of $300,000 and $100,000 respectively. As the new machine is more efficient it will also require an increase in net working capital of $2,000,000 today. Victoria Energy depreciates all assets using straight-line method over their useful life and pays tax at the company rate of 30%. The terminal cash flows (excluding the final year operational cash flows) for the decision is (to the nearest dollar):

Select one:

$5,600,000

$2,800,000

$4,400,000

$4,000,000

$4,800,000

Answer 1

Answer : Correct Option is $4,000,000

Reason :

Terminal Value of Cash Flow is the the after tax salvage value .

After tax salvage Value = Salvage Value - Tax on Salvage Value

= 4,000,000 - 0

= 4,000,000

Tax on Gain on Salvage value is zero as the book value at the end of year 10 and salvage value is same.