Calculate terminal value. Your company is considering replacing a fully deprecia

Question

Calculate terminal value. Your company is considering replacing a fully depreciated machine that has a remaining useful life on 10 years with a newer, more sophisticated machine. This new machine will cost $200,000 and will require $30,000 installation costs. It will be depreciated using MACRS 5 year (20%, 32%, 19%, 12%, 12%, and 5%). A $25,000 increase in net working capital will be required to support the new machine. The management plans to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $15,000 before taxes; the new machine at the end of 4 years will be worth $75,000 before taxes.

Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 40% tax rate.

Explanation / Answer

Cost of machine $ 200,000.00 Depreciation for first 4 years (20+32+19+12%) $ 166,000.00 Book value of machine at the end of year 4 $    34,000.00 Estimated sale price $    15,000.00 Loss on sale $    19,000.00 Tax saving on loss (40%) $      7,600.00 Total terminal value $    22,600.00

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