BUS202: Principles of Finance

These videos show you how to work with a depreciating asset in an income statement. When a replacement project is being considered, the initial investment is composed of the cost of the new project plus any installation or cleaning costs minus the after-tax cash flow from selling the current project. The MACRS depreciation schedule is used to estimate the current value of a physical asset, such as a computer, at any moment of this asset's life. That value is called the "book value". When a replacement project is being considered, the incremental operating cash flows need to be computed every period starting with period 1 as follows:

incremental $C_1 = C_1$ from the new project $- C_1$ from the current project

When a replacement project is being considered, the terminal cash flow is the cash flow that will be generated in the last period of the project. This is an important concept when machines with a long life are intended to be used for short periods until the end of a project. After the project is over, a long-lasting machine could either be sold to a buyer at the given market price or sold as scrap for a lower amount than its remaining book value.