Your firm is contemplating the purchase of a new $749,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $749,000 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $45,000 at the end of that time. You will save $165,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $40,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

If the tax rate is 40 percent, what is the IRR for this project?

Your firm is contemplating the purchase of a new $749,000 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $45,000 at the end of that time. You will save $165,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $40,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

If the tax rate is 40 percent, what is the IRR for this project?

Explanation / Answer

Hi,

Please find the answer as follows:

Initial Investment = -749000 + 40000 = -709000

Operating Cash Flow = 165000*(1-.40) + (749000/7)*.40 = 141800

To calculate IRR, we need to keep the value of NPV as 0

NPV = 0 = -709000 + 141800/(1+r)^1 + 141800/(1+r)^2 + 141800/(1+r)^3 + 141800/(1+r)^4 + 141800/(1+r)^5 + 141800/(1+r)^6 + 141800/(1+r)^7 + 45000*(1-.40)/(1+r)^7 - 40000/(1+r)^7 = 8.90 or 9% is the IRR

IRR is 8.90% or 9%

Thanks.

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