Termination cash flow

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Termination cash flow
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Terminal cash flow is the cash flow that appears at the end of a project and shows the after-tax proceeds from sale of the project assets and reward of working capital[1].

Main definition

Terminal cash flow has two main elements[2]:

  • Proceeds from sale of project implement;
  • cash flows associated with resumption of working capital to the level that dominated before the start of the project.

Terminal cash flow is an important inset in the capital budgeting process. While uniform periodic net cash flows are discounted using the present value for rent formula, terminal cash flow is treated separately from other cash flows and discounted using the present value of a single sum formula[3].

Formula of the Terminal cash flow

Terminal cash flow can be calculated using the following formula[4]\[\text TCF =\text P_n - \text P_o - \text T_n + \text T_o + \text R \]

where

  • TCF - Terminal cash flow;
  • Pn - Proceeds from sale of new asset;
  • Po - Proceeds from sale of old asset;
  • Tn - Taxes on sale of new asset;
  • To - Taxes on sale of old asset;
  • R - Recovery of working capital.

Example

Company X wants to increase its present value of sales purchasing a new machine because the new equipment enables the company to increase its production. The cost of buying the new machine is $100000, the life of the machine is 7 years, and its scrap value after that is $20000. After the company buys the machine, the working capital requirements to maintain and operate the machine will cost the firm $10000. At the end of the lifetime of the machine, terminal cash flow value of the machine can be intent. To calculate this, the salvage value of the machine is added to the amount the business recovers in working capital by having and using the machine, so in this situation, the terminal cash flow equals $20000 + $10000 = $30000.

Footnotes

  1. Sharan V., 2012, p.252
  2. Besley S., 2008, p.252
  3. Sharan V, 2008, p.432
  4. Dayananda D., 2002, p.32

References

Author: Valentyna Ilyina