Your firm is contemplating the purchase of a new $636,000 computer-based order e
ID: 2778462 • Letter: Y
Question
Your firm is contemplating the purchase of a new $636,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $43,000 at the end of that time. You will save $163,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $38,000 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 percent, what is the IRR for this project? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Your firm is contemplating the purchase of a new $636,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $43,000 at the end of that time. You will save $163,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $38,000 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 percent, what is the IRR for this project? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Explanation / Answer
Answer:
The Internal rate of return (IRR) is the the interest rate that would result in the present value of the capital investment, or cash outflow, being equal to the value of the total returns over time, or cash inflow.
IRR can be calculated as follows:
NPV= {Period Cash Flow / (1+R)^T} - Initial Investment
where R is the interest rate and T is the number of time periods. IRR is calculated using the NPV formula by solving for R if the NPV equals zero.
Hence, Cash flow for year 0 = Initial Investment less working capital changes= 636,000 - 38,000 = $598,000
Cash flow for year 1 to Year 5 = (Savings in cost before tax - depreciation ) - tax on the same @30% = 44,916* 5 = $ 224581 . (163000-98344[(636000-43000)/6])- (6465*30/100) ; here the snawer is multiplied by 5 as it is for 5 year i.e, year 1, year 2, year 3, year and year 5.
Cash Flow for Year 6 = (Savings in Cost + Salvage of Assets ) - tax on the same @30% = 144200 (163000+43000) - ( 206000*30/100)
Hence,
IRR here is 28%
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