Your firm is contemplating the purchase of a new $1,049,000 computer-based order

ID: 2651537 • Letter: Y

Question

Your firm is contemplating the purchase of a new $1,049,000 computer-based order entry system. The system will be depreciated straight-line to to zero over its 3 year life. If will be worth $156,300 at the end of that time. You will save $423,500 before taxes per year in order processing costs tand you will be able to reduce working capital by $115,764(this is a one-time reduction). The net working capital will return to its oringinal level when the project ends. The tax rate is 35%. What is the IRR for this 3 year project?

11.78

13.49

18.21

12.74

13.58

Explanation / Answer

Answer:

Calculation of IRR of the Project :

Year 0

Year 1

Year 2

Year 3

Purchase Cost of Machine

$ (1,049,000.00)

Saving In Annual Costs (Net of tax)

$ 275,275.00

423500*(1-0.35)

Tax Saving on Depreciation (1049000/3)*35%

$ 122,383.33

Terminal Sale value of machine (Net of tax)

$ 101,595.00

156300*(1-0.35)

Working Capital reduction

$ 115,764.00

$ (115,764.00)

Net cash flows

$ (933,236.00)

$ 397,658.33

$ 383,489.33

IRR =

12.74%