Is the IRR more or less than the cost of capital? Ferris Company is considering

Question

Is the IRR more or less than the cost of capital?

Ferris Company is considering investing in new equipments that would cost $80,000 and have a 5-year useful life and zero salvage value. Expected changes in annual revenues and expenses if the new machine is purchased are as follows: Increased Revenue $63,000 Increased Expenses Salary of additional operator 10,000 Supplies 9,000 Depreciation 16,000 Maintenance 3,600 38,600 Increased Income (Pre-tax) 24,400 Taxes (40%) 9,760 Increased Operating Income 14,640 The company has a debt to equity ratio of 1.5 (1.5 to 1). The pre-tax cost of debt is 10% and the cost of equity is 16%.

Explanation / Answer

Using a TI BAII calculator I get the IRR to be 26.46% The cost of capital is 10% (1-.4) *.6= 3.6% (debt) and 16% *.6= 6.4% (equity) so total is 10% So IRR is clearly greater.

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