Your firm is contemplating the purchase of a new $620,000 computer-based order e
ID: 2642325 • Letter: Y
Question
Your firm is contemplating the purchase of a new $620,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $68,000 at the end of that time. You will save $250,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $83,000 (this is a one-time reduction). If the tax rate is 34 percent, what is the IRR for this project? (Round your answer to 2 decimal places. (e.g., 32.16))
IRR %Explanation / Answer
Internal Rate of Return (IRR) is that rate of return from the above investments at which the NPV will become zero. It is that rate of interest that makes the sum of all cash flows zero
IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively
Calculation of Yearly Cash Flows
Year
0
1
2
3
4
5
Investment(I)
(620,000)
-
-
-
-
-
Scrap Value(a)
-
-
-
-
-
68,000
Saving Before Taxes(b)
-
250,000
250,000
250,000
250,000
250,000
Reduction in working capit[c]
-
83,000
-
-
-
-
Depreciation(considering zero value at end of life)(Costof Machinery/5){d}
-
124,000
124,000
124,000
124,000
124,000
Profit before Tax(e)
{a+b+c-d}
-
209,000
126,000
126,000
126,000
194,000
Tax Rate
34%
34%
34%
34%
34%
34%
Tax Amount(f)
-
71,060
42,840
42,840
42,840
65,960
Profit After Tax(g){e-f}
-
137,940
83,160
83,160
83,160
128,040
Cash Flow(h){I+g+d}
(620,000)
261,940
207,160
207,160
207,160
252,040
Calculation by trial method that NPV shall be zero by considering discount rate as 24.65%
Time Period (T)
Cash Flow
Discount Rate (DR)(24.65%)
Discounting Factor
='Discounting Factor
NPV of Cash Flow{Cash Flow *DF}
0
(620,000)
1.0000
1
1.000
(620,000)
1
261,940
1.2465
1/1.2465
0.802
210,141
2
207,160
1.2465
1/(12465)^2
0.644
133,329
3
207,160
1.2465
1/(12465)^3
0.516
106,963
4
207,160
1.2465
1/(12465)^4
0.414
85,811
5
252,040
1.2465
1/(12465)^5
0.332
83,756
NPV
(0)
Since NPV at discoubnt rate 24.65% is 0, therefore IRR of the project is 24.65%
Calculation of Yearly Cash Flows
Year
0
1
2
3
4
5
Investment(I)
(620,000)
-
-
-
-
-
Scrap Value(a)
-
-
-
-
-
68,000
Saving Before Taxes(b)
-
250,000
250,000
250,000
250,000
250,000
Reduction in working capit[c]
-
83,000
-
-
-
-
Depreciation(considering zero value at end of life)(Costof Machinery/5){d}
-
124,000
124,000
124,000
124,000
124,000
Profit before Tax(e)
{a+b+c-d}
-
209,000
126,000
126,000
126,000
194,000
Tax Rate
34%
34%
34%
34%
34%
34%
Tax Amount(f)
-
71,060
42,840
42,840
42,840
65,960
Profit After Tax(g){e-f}
-
137,940
83,160
83,160
83,160
128,040
Cash Flow(h){I+g+d}
(620,000)
261,940
207,160
207,160
207,160
252,040
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