This is a practice problem and I am not able to come up with the answer the prof

Question

This is a practice problem and I am not able to come up with the answer the prof. gives. Please help with a step by step on how to figure this out either with a financial calculator or on an Excel spreadsheet.

Gorton Industries is considering the purchase of a new machine which will cost $120,000, plus an additional $7500 to ship and install. The new machine will have a 5 year useful life and will be depreciated to zero using the straight line method. The machine is expected to generate new sales of $25,000 per year and is expected to save $17,000 in labor and electrical expenses over the next 5 years. The machine is expected to have a salvage value of $30,000. Gorton's income tax rate is 40%. What is the machine's IRR?

I know that the initial outlay is $127,500 (machine +ship and install)
Depreciation is 127,500/5 = $25,500 per year for 5 years
There would be an offset in operating expenses of $3400 per year due to the $17,000 savings in labor and electrical.
Then there is the salvage at year 5 which changes the tax and operating cash flow.

That is what throws me. CAN SOMEONE PLEASE EXPLAIN THIS IN THE SIMPLEST TERMS POSSIBLE? Thanks in advance

Explanation / Answer

Keep in mind that all cash flow/capital budgeting questions follow the same format. It is all a matter of getting all of the pieces together. 1. Determine the initial cash flow out 2. Determine the subsequent years' cash flows 3. Determine the cost of capital (a/k/a discount rate, expect rate of return, or investment rate) 4. Calculate NPV and IRR Note that IRR must be calculated using a financial calculator as IRR is a mathematical, iterative process. Initial Cash Flow Out: 120,000 + 7,500 = $127,500 Subsequent Cash Flow (Years 1-5) Additional revenue: 25,000 Add: Oper Ex Savings: 17,000 Less: Depreciation: (127,500 - 30,000)/5 = $19,500/yr (assuming straight-line) Tax (.4 * 22,500) = 9000 Net Income: 13,500 FCF (yrs 1-5): 13,500 + 19,500 = 33,000 (add back depreciation as a non-cash expense) The resulting project line would be as follows: CF(0)...initial cash flow = 127,500 CF(1-5)...subsequent cash flow = 33,000 CF(5)...salvage value = 30,000 Use: PV = FV/(1+r)^n for subsequent and salvage value cash flows where PV = Present value FV= Future value (cash flow) r = discount rate or investment rate or expected rate of return n = year or period example - salvage value cash flow PV = 30,000/(1+r)^5 If you are using a financial calculator, be sure to add the fifth year cash flow to the salvage value...this will provide a total fifth year cash flow to be discounted.

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