A project requires an initial investment of $200,000 and expects to produce a ca

Question

A project requires an initial investment of $200,000 and expects to produce a cash flow before taxes of 120,000 per year for two years (i.e. cash flows will occur at t = 1 and t = 2). The corporate tax rate is 30%. The assets will depreciate using the MACRS year 3 schedule: (t = 1: 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can use all applicable tax shields. The opportunity cost of capital is 11%. Assume that the asset can sell for book value at the end of the project. Calculate the approximate IRR for the project.

12.00%

11.00%

17.73%

14.06%

12.00%

11.00%

17.73%

14.06%

Explanation / Answer

IRR is the rate at which the NPV of the project is zero, by usnig trial and error method:

As the NPV is truning negative between 17% and 18%. by interpolating between 17% and 18%

IRR = 17% +($1947 -$715)/$1947

=17%+.63%

=17.63$ is the IRR of the project.

Year Cash inflow Depreciation Profit after depreciation Tax Profit after tax Cash inflows after addition of depreciation Present value factor Present value 0 -$200,000.00 1 -$200,000.00 1 $120,000.00 $66,000.00 $54,000.00 $16,200.00 $37,800.00 $103,800.00 0.9009009 $93,513.51 2 $120,000.00 $90,000.00 $30,000.00 $9,000.00 $21,000.00 $111,000.00 0.81162243 $90,090.09 2 $44,000.00 $44,000.00 0.81162243 $35,711.39 Total $19,314.99

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