Your firm is contemplating the purchase of a new $620,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $620,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $68,000 at the end of that time. You will save $250,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $83,000 (this is a one-time reduction). If the tax rate is 34 percent, what is the IRR for this project? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) IRR %

Explanation / Answer

Solution:

NPV @ 15 % 0 1 2 3 4 5 Initial Investment 620,000 Saving in processing costs          250,000          250,000          250,000          250,000          250,000 Add: Reduction in working capital            83,000 Less: Depreciation - ( $ 620,000 - $ 68,000 / 5)          110,400          110,400          110,400          110,400          110,400 Net savings before tax          222,600          139,600          139,600          139,600          139,600 Less: tax expense - 34 %            75,684            47,464            47,464            47,464            47,464 Net savingsa after tax          146,916            92,136            92,136            92,136            92,136 Add: Depreciation          110,400          110,400          110,400          110,400          110,400 Cash inflows          257,316          202,536          202,536          202,536          202,536 Add: Salavage value            60,000 Cash inflows          257,316          202,536          202,536          202,536          262,536 Present value of $ 1 @ 15 %              0.870              0.756              0.658              0.572              0.497    223,753.04    153,146.31    133,170.71    115,800.62    130,526.79 Total present value of ash inflows                                                                                                                756,397.47 NPV = Present value of cash inflow - inItial investment                                                                                                                                     136,397.47 NPV @ 25 % 0 1 2 3 4 5 Initial Investment 620,000 Saving in processing costs          250,000          250,000          250,000          250,000          250,000 Add: Reduction in working capital            83,000 Less: Depreciation - ( $ 620,000 - $ 68,000 / 5)          110,400          110,400          110,400          110,400          110,400 Net savings before tax          222,600          139,600          139,600          139,600          139,600 Less: tax expense - 34 %            75,684            47,464            47,464            47,464            47,464 Net savingsa after tax          146,916            92,136            92,136            92,136            92,136 Add: Depreciation          110,400          110,400          110,400          110,400          110,400 Cash inflows          257,316          202,536          202,536          202,536          202,536 Add: Salavage value            60,000 Cash inflows          257,316          202,536          202,536          202,536          262,536 Present value of $ 1 @ 25 %              0.800              0.640              0.512              0.410              0.328    205,852.80    129,623.04    103,698.43      82,958.75      86,027.80 Total present value of ash inflows 608,160.81 NPV = Present value of cash inflow - inItial investment     -     11,839.19 IRR = 15 % + 136,397.47 /(136,397.47 - ( - 11,839.19))*10% = 24.20 %

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