Introduction to Finance

LEARNING ACTIVITY
Some fi rms sell old equipment on auction sites, such as http://www.ebay.com, to recover 
fi nal or “salvage” cash fl ows at the end of a project’s term. Another more business-
oriented site is http://www.salvagesale.com. 
17.13
Applications
In this section, we review practical applications of cash fl ow estimation for a revenue expanding 
project, for a cost-saving project, and in setting a bid price.
Cash Flow Estimation for a Revenue Expanding Project 
Let’s examine a fi rm’s decision to build an addition to a present plant in response to a forecast 
showing rising sales. For simplicity, we’ll assume construction for the addition occurs in year 
zero. The plant has an expected useful life of fi ve years and can be sold for $1 million at the 
end of the project. We need to determine the initial outlay, the incremental after-tax operating 

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17.13 Applications
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cash fl ow, and the salvage value for the project. We will assume the project’s minimum 
required return is 10 percent and its tax rate is 40 percent.
Initial Outlay
The up-front expenses include those that are depreciable for tax purposes 
and those that are not depreciable. Depreciable outlays include construction labor, mater-
ials, preparation and transportation of materials, and equipment in the plant addition. For 
this example, we’ll assume depreciable outlays are $4.5 million in year zero. Other expenses 
include costs for additional workers to operate the new plant and expenses associated with 
hiring, relocating, and training the workers. As with other expenses, this cost is deducted from 
the project’s year-zero taxable income. The plant managers estimate that these costs will total 
$0.4 million after tax.
As seen in 
Table LE17.1
, the initial after-tax outlays are $4.9 million in year zero. Of this 
cost, $4.5 million is depreciable while the remaining $0.4 million is expensed in year zero.