Your firm is contemplating the purchase of a new $674,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $674,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $58,000 at that time. You will save $185,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $29,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 34 percent, what is the IRR for this project?

Explanation / Answer

Hi,

Please find the answer as follows:

Initial Cash Flow = -674000 + 29000 = -645000

Annual Cash Flow = 185000*(1-.34) + 674000/6*.34 = 160293.33

Final Year Cash Flow = 160293.33 + 58000*(1-.34) - 29000 = 169573.33

To calculate IRR, you need to put the value of NPV as 0 and solve for r as follows:

NPV = 0 = -645000 + 160293.33/(1+r)^1 + 160293.33/(1+r)^2 + 160293.33/(1+r)^3 + 160293.33/(1+r)^4 + 160293.33/(1+r)^5 + 169573.33/(1+r)^6

Solving for r, we get IRR as 13.01% (you can Trial or Error method Excel's IRR function to get IRR)

Answer is 13.01%

Thanks.

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