Principles of Managerial Finance

CHAPTER 8 Capital Budgeting Cash Flows 377

Time line for Powell
Corporation’s relevant
cash flows with the
proposed machine

0

$221,160

End of Year

5

$128,200 Total Cash Flow

73,200 Operating Cash Inflow

$55,000Terminal Cash Flow

4

$61,200

3

$55,600

2

$57,680

1

$26,480

Hint Capital expendi-
tures are critical to a firm’s
success, and these funds are
usually limited. Because of
this, the process of deter-
mining cash flows should be
finely tuned so that it is both
objective and realistic.

LG4 LG5 LG6

proceeds$12,000 taxes). Because the present machine would net $0 at termi-

nation and its book value would be $0, no tax would be due on its sale. Its after-

tax sale proceeds would therefore equal $0. Substituting the appropriate values

into the format in Table 8.10 results in the terminal cash inflow of $55,000.

After-tax proceeds from sale of proposed machine

Proceeds from sale of proposed machine $50,000

Tax on sale of proposed machine  (^1)  (^2) , (^0)  (^0)  (^0) 
Total after-tax proceeds—proposed $38,000
After-tax proceeds from sale of present machine
Proceeds from sale of present machine $ 0
Tax on sale of present machine  (^0) 
Total after-tax proceeds—present 0
Change in net working capital 17,000
Terminal cash flow $

5

5

,

0

0

0

Review Question
8–15 Explain how theterminal cash flowis calculated for replacement projects.
8.6 Summarizing the Relevant Cash Flows
The initial investment, operating cash inflows, and terminal cash flow together
represent a project’s relevant cash flows.These cash flows can be viewed as the
incremental after-tax cash flows attributable to the proposed project. They repre-
sent, in a cash flow sense, how much better or worse off the firm will be if it
chooses to implement the proposal.
EXAMPLE The relevant cash flows for Powell Corporation’s proposed replacement expendi-
ture can now be shown graphically, on a time line. Note that because the new
asset is assumed to be sold at the end of its 5-year usable life, the year-6 incre-
mental operating cash inflow calculated in Table 8.9 has no relevance; the termi-
nal cash flow effectively replaces this value in the analysis. As the following time
line shows, the relevant cash flows follow a conventional cash flow pattern.