Free Cash Flow Adjustments

After converting earnings to cash flows, there are some other adjustments we need to consider.

Liquidation/Salvage Value

This is just the book value of an asset, given by

$$\text{Book value}=\text{Purchase price}-\text{Accumulated depreciation}$$

If the sale price (SV) is different from the book value (BV), there will be a tax effect:

• SV > BV → Capital gain → Tax due
• SV < BV → Capital loss → Tax credit

This gives

$$\text{After-Tax Cash Flow from Asset Sale}=\text{Sale Price}-(t_c\times \text{Capital Gain})$$

Timing of Cash Flows

Cash flows may be monthly, quarterly, or annual.

Accelerated Depreciation: MACRS

Modified Accelerated Cost Recovery System

• Allows for larger depreciation deductions earlier in the asset’s life, which increases PV of the tax shield
• Method used to compute depreciation expenses is governed by the depreciation schedule required by the relevant tax authority (e.g. IRS in the US, IRD in HK)

Tax Carryforwards

• Tax loss carryforwards and carrybacks allow corporations to take losses during its current year and offset them against gains in nearby years.