Your firm is contemplating the purchase of a new $540,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $540,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $52,000 at the end of that time. You will save $300,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $67,000 (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))

Please show math, specifically for Year 5

IRR % = ???

Explanation / Answer

Cost of Machine (Initial Investment) = $540,000
Depreciation per year = $540,000/5 = $108,000
After tax saving per year = $300,000 x (1-0.35) = $195,000
Change in working capital in year 1 = $67,000
After tax salvage Value of Machine = $52,000 x (1-0.35) = $33,800

Cash Inflow in Year 1 = $195,000 + $108,000 + $52,000 = $355,000
Cash Inflow in Year 2, 3 & 4 = $195,000 + $108,000 = $303,000
Cash Inflow in Year 5 = $195,000 + $108,000 + $33,800 - $67,000 = $269,800

             IRR:

0 = -$540,000 + [($355,000)/(IRR)] + [($303,000)/(IRR)2] + [($303,000)/(IRR)3] + [($303,000)/(IRR)4] + [($269,800)/(IRR)5] = 52.1320%

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