Terminal year non-operating cash flow for replacement project

CFA Level II Corporate Finance
#1

When calculating the terminal year non-operating cash flow for replacement project, we do we subtract the slavage value of the old one?

Isn’t we taking into account of the old equipment in the first place? We sold the old equipment when purchasing the new one, and the cash flow occured in the beginning, thus we need to subtract the gain from the sale of the old equipment from the inital outlay. Initial outlay = FC + WC - (old salvage value at time 0 - T * (salvage value - book value)).

So again, my question is why do the old salvage value appears in the calculation of the terminal value?

Thanks.

#2

Start new project:

When you replace old machine --> sell old machine --> buy new machine

After project done:

Sell the old (new) machine because you don’t need it anymore

#3

Yes I understand this. But,

Terminal-year alter-tax non-operating cash flow = (Sal new - sal old) + NWC - T ( (sal new - book new) - (sal old - book old) )

I don’t understand why we subtract the old sal from the new sal? We have already sold the old machine when starting the new project, but why the old machine appreas again?

Thanks.

#4

the thing is we are taking incremental of everything in our calculation.it is looking at the incremental NPV of the new project so every line item must be incremental ie cogs ,sales,depreciation,salvage value.

#5

Could someone come back on this? Thanks

#6

We are looking at incremental cashflows. You would have sold the old machine at the end of the valuation period if you hadnt replaced it with a new one . By subtracting salvage of old from salvage of new, you are signifying the opportunity cost i.e. lost cashflow at the end of the period.

#7

But still, isn’t it ENOUGH to include it in the initial outlay? I mean we already signified the opportunity cost in the initial outlay !!