Your firm is contemplating the purchase of a new $570,000 computer-based order e
ID: 2744312 • Letter: Y
Question
Your firm is contemplating the purchase of a new $570,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $58,000 at the end of that time. You will save $270,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $73,000 (this is a one-time reduction). If the tax rate is 35 percent, what is the IRR for this project? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16)) IRR %Explanation / Answer
Initial Investment = cost of asset – change in working capital
= 570,000 -73,000
= 497,000
Annual depreciation = (cost of asset – salvage value)/ life of the asset
= (570,000 – 0)/5
= 114,000
Net salvage value = salvage value x (1-t)
= 58,000 x (1-0.35)
= 37,700
OCF = cost saving x (1-t) + Depreciation x tax rate
= 270,000 x (1-0.35) + 114,000 x 0.35
= 215,400
Terminal cash flow (year 5) = 215400 -73000+37,700
= 180100
Now we can use IRR function in excel and calculate IRR:
Year
Cash flow
0
-497000
1
215400
2
215400
3
215400
4
215400
5
180100
IRR
31.93%
Therefore, IRR would be 31.93%.
Year
Cash flow
0
-497000
1
215400
2
215400
3
215400
4
215400
5
180100
IRR
31.93%
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