Terminal cash flow refers to the cash flow, which takes place at the end of the project life. Terminal cash flow takes into account a net salvage value received at the end (liquidation) of the project (such as sale of the asset).
Terminal cash flow excludes operation cash inflow from the last year of the project but includes cash flow due to change in net working capital. Generally, change in net working capital results in the cash inflow which is the recovered amount of cash outflow (due to increase in net working capital) that were taken into account at the beginning of the project (when calculating the initial investment).
The calculation of the terminal cash flow is as follows:
After-tax proceeds from the new asset
LESS: After-tax proceeds from the old asset
LESS/ADD: Change in net working capital
= TERMINAL CASH FLOW
As stated above, when we calculate a terminal cash flow, we reverse the change in net working capital, which was taken into account during the calculation of the initial cash outflow (initial investment) .
If there was an increase in net working capital at the beginning of the project than we see it as inflow when calculating the terminal cash flow and vice versa. In other words, if there was an outflow due to change in net working capital at the beginning of the project than we reverse it by adding it back during calculation of the terminal cash flow.
Tax considerations in calculation of the terminal cash flow are the same as explained in initial cash outflow (initial investment) section earlier.
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