Your firm is contemplating the purchase of a new $663,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $663,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $52,000 at the end of that time. You will save $172,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $47,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

If the tax rate is 35 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 $663,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $52,000 at the end of that time. You will save $172,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $47,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

Explanation / Answer

Solution-

Annual depreciation charge = $663,000/6

Annual depreciation charge = $110,500

Aftertax salvage value = $52,000*(1 – 0.35)

Aftertax salvage value = $33,800

Using the tax shield approach

OCF = $172,000(1 – 0.35) + 0.35($110,500)

OCF = $150,475

NPV = 0 = –$663,000 + $47,000 + $150,475(PVIFAIRR%,6) + [($33,800 – 47,000) / (1+IRR)6]

IRR = 11.77%

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