Input Investment Salvage Value Useful Life WDV Investment Analysis Year Investment Depriciation Acc Dep Book

Value Salvage Value WC Chage

1000 100 6 25%

0 1000

1 250 250

2 188 438

3 141 578

4 105 684

5 79 763

6 59 822 178 100 0

20

30

50

70

70

30

Projected P& L Revenue Expenses Dep EBIT Marginal Tax (35%) PAT 1 550 -300 -250 0 0 0 2 890 -472 -188 231 81 150 3 1840 -958 -141 741 259 482 4 2020 -1075 -105 840 294 546 5 1680 -890 -79 711 249 462 6 1300 -680 -59 561 196 364

Incremental Cash Flow Initial Investment PAT Dep Change in WC FCFF Salvage Value Total Cash Flows -1020 240 317 603 651 581 -1020 0 250 -10 240 150 188 -20 317 482 141 -20 603 546 105 0 651 462 79 40 581 364 59 30 454 127.3 581

-1020

TERMINAL CASH FLOWS : SALVAGE VALUE Salvage Value of the New asset: Will increase cash flows in the terminal period of the new investment Salvage value of the existing asset now: It will reduce the initial outlay of the new asset now or increase cash inflow in the first year Salvage value of the existing asset at the end of its normal life: It will reduct the cash flow of the new investment of the terminal period. TAX EFFECT OF SALVAGE VALUE Salvage value is subjected to normal tax or normal tax and capital gains tax Example: Orginal cost of the asset Depreciation Book value or WDV value Rs.10,000 Rs. 6,000 Rs. 4,000

(a) Salvage value of the asset Salvage value Book value Loss Tax rate is 35% Cash inflows in Terminal period Salvage value Tax credit on loss Cash inflows in Terminal period (b) Salvage Value of the asset Salvage value Book value Profit Tax rate is 35% Cash inflows in terminal period Salvage value Tax on profit Cash inflows in terminal period (c ) Salvage value of the asset Salvage value Book value Profit Tax rate is 35%

Rs. 2000 Rs. 2,000 Rs. 4,000 Rs. 2,000

2,000 700 2,700 Rs. 5,000 Rs. 5,000 Rs. 4,000 Rs. 1,000

5,000 350 4,650 Rs.10,000 Rs.10,000 Rs. 6,000 Rs. 4,000

Cash inflows in the terminal period Salvage value Tax on profit Cash inflows in terminal period (d) Salvage value of the asset Salvage value Book value Proft Tax on normal profit (35%) Tax on capital gains (30%) Cash inflows in the terminal period Salvage value Tax on normal profit (equal to depreciation) Capital gains (excess of OV) Cash inflows in the terminal period

10,000 1400 8,600 Rs.11,000 Rs.11,000 Rs. 6,000 Rs. 5,000

11,000 1400 300 9,300

BLOCK OF ASSETS ( As applicable in India) In India depreciation is calculated on block of assets Salvage value is not subjected to taxes

Block of assets = Written down value of old equipment Plus Cost of the new equipment Minus Salvage value of the existing equipment
REPLACEMENT EXAMPLE Inputs Cost of new equipment Book value of the old equipment Salvage value of the old equipment (now) Salvage value of the new equipment (after 5 years) Salvage value of the old equipment ( after 5 years)

Rs.1,60,000 Rs. 40,000 Rs. 20,000 Rs. 8,000 Rs. 2,000

(a) Block of asset basis Cost of the new asset Cost of the old asset Less Salvage value of the old asset (now) Block of assets Life 5 years Tax rate 35% Depreciation

After purchase Before Purchase 160000 40000 20000 180000

40000

New

Old

Differential

Block of assets Depreciation on WDV 1 2 3 4 5 Total depreciation Written down value Cash outflow in year 1 Cost of the new machine Less salvage value of the old machine

180000 25% 45000 33750 25313 18984 14238

40000 25% 10000 7500 5625 4219 3164 35000 26250 19688 14766 11074 106777 33223

160000 20000 140000

Cash inflow in year 5 (Salvage value) Salvage value of the new machine Minus salvage value of the old machine 8000 2000 6000

OTHER THAN BLOCK OF ASSETS After Purchase Before Purchase 160000 40000

ASSET VALUE Depreciation on WDV (25%) Life 5 years Tax rate 35% Depreciation 1 2 3 4 5 Total depreciation WDV or book value at the end of 5 years Cash outflow in the first year Cost of the new machine Salvage value Cash outflow Salvage value cash inflow calcuations

New Machine machine ifferential Old D 40000 10000 30000 30000 7500 22500 22500 5625 16875 16875 4219 12656 12656 3164 9492 122031 30508 37969 9492

160000 20700 139300

Orginal cost of the old machine Written down value Salvage value Loss Cash inflows from salvage value Salvage value Tax credit on loss

80000 (say) 40000 20000 20000

20000 700 20700

Cash inflow at the end of the project Differential in Salvage value after adjusting for taxes. New machine machine Old 37969 9492 8000 2000 29969 7492

WDV or book value of the machine Salvage value Loss Cash inflow

Differential Salvage value Tax credit on loss 8000 10489 18489 2000 2622 4622

13867

ew investment now or increase cash inflow

low of the new investment of

Cashflows New Machine Old Machine Revenue Cost Revenue Cost CF(New_) CF(Old) IncrementalAfter Tax Incremenmtal 250000 130000 200000 140000 120000 60000 60000 39000

Tax shield

CF

TCF

Salvage Value Salvage Value Lost

CF

140000

-140000

12250 9188 6891 5168 3876 37372 11628

1 2 3 4 5

12250 9188 6891 5168 3876

6460

6000

-1166.67

51250 48188 45891 44168 54169 $4,832.09

Tax shield 10500 7875 5906 4430 3322

ncremenmtal