Kadalai Company makes metal blanks which it sells to metal fabrication and stamp

Question

Kadalai Company makes metal blanks which it sells to metal fabrication and stamping companies. The sales forecasts for the next four years are 415,000 bars a year. The president estimates that he can save $2,100 per year in fixed cash operating costs plus $0.05/bar during the next four years if he buys a machine to automate the process at a cost of $79,000. A salvage value of $15,400 is expected at the end of the four-year period. The company’s minimum desired rate of return is 9%. The company’s average tax rate is 20%.

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables.

What is the internal rate of return for the investment in the machine? (Round discount factor(s) to 3 decimal places and final answer to 2 decimal places. (i.e., 0.1234 should be considered as 12.34%).)

Kadalai Company makes metal blanks which it sells to metal fabrication and stamping companies. The sales forecasts for the next four years are 415,000 bars a year. The president estimates that he can save $2,100 per year in fixed cash operating costs plus $0.05/bar during the next four years if he buys a machine to automate the process at a cost of $79,000. A salvage value of $15,400 is expected at the end of the four-year period. The company’s minimum desired rate of return is 9%. The company’s average tax rate is 20%.

Explanation / Answer

The IRR can be calculated in the excel using the below formula:

= IRR (Series of cash flows)

The cash flows for the years can be calculated as:

Year 0: -79000

Year 1 to 3: Net costs savings after taxes plus depreciation tax savings

Net costs savings = (2100+0.05*415000)*(1-0.2) = 18280

Depreciation Tax savings = ((79000-15400)/4)*0.2 = 3180

So, Year 1 to 3 = 18280+3180 = 21460

Year 4 = 21460 + salvage value

= 21460 + 15400

= 36860

So, IRR = IRR(-79000, 21460, 21460, 21460, 36860)

= 9.755%

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