Mills Mining is considering an expansion project. The proposed project has the f
ID: 2765657 • Letter: M
Question
Mills Mining is considering an expansion project. The proposed project has the following features. The project has an initial cost of $684--this is also the amount which can be depreciated using the following depreciation schedule: Year 1 is 33%, Year 2 is 45%, Year 3 is 15%, and Year 4 is 7%. If the project is undertaken, at t = 0 the company will need to increase its inventories by $85, and its accounts payable will rise by $53. This net operating working capital will be recovered at the end of the projects life (t = 4). If the project is undertaken, the company will realize an additional $799 in sales over each of the next four years (t = 1, 2, 3, 4). The company’s operating cost (not including depreciation) will equal $214 a year. The company’s tax rate is 40 percent. At t = 4, the projects economic life is complete, but it will have a salvage value of $145. The projects WACC = 10 percent. What are the one-time cash flows associated with ending the project (i.e. terminal Cash Flows)?
Explanation / Answer
The one-time cash flows associated with ending the project (i.e. terminal Cash Flows):
Terminal cash flow is the net cash flow that occurs at the end of a project and represents the after-tax proceeds from disposal of the project assets and recoupment of working capital.
Formula
Terminal cash flow has two main components:
It is calculated using the following formula:
Terminal Cash Flow = After-tax Proceeds from Disposal ± Change in Working Capital
After-tax Proceeds from Disposal = Pre-tax Proceeds from Disposal Tax on gain on Disposal
=$145 - $38.848 = $106.152 is the After-tax Proceeds from Disposal
Tax on Gain on Disposal = (Pre-tax Proceeds from Disposal Ending Book Value) × Tax Rate
Tax on Disposal = (Proceeds Book Value) × Tax Rate
=($145-$47.88) * 40% = $38.848 is the Tax on disposal
here Book Value = $684-93% = $47.88
(note: 93% comes by adding depreciation percentage from year 1 to year3 = 33% + 45% + 15% = 93%)
Threrfore, Terminal Cash Flow = After-tax Proceeds from Disposal ± Change in Working Capital
Terminal Cash Flow = After-tax Proceeds from Disposal + Working Capital Recouped
= $106.152 + ($85 + $53) = $244.152 is the Net terminal cash flow