Your firm is contemplating the purchase of a new $648,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $648,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $47,000 at the end of that time. You will save $167,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $42,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 30%, what is the IRR for this project?

Explanation / Answer

Answer: To evaluate the project with a $167,000 cost savings, we need the OCF to compute the IRR.

Using the tax shield approach, the OCF is:

OCF = $167,000(1 – 0.30) + 0.30($108,000) = $116900+32400=$149300

NPV =0= – $648,000 + 42,000 + $149300(PVIFA IRR%,6 ) + [($32900 – 42,000) / (1+IRR) 6 ]

IRR=12.19%

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