Your firm is contemplating the purchase of a new $636,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $636,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $43,000 at the end of that time. You will save $163,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $38,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

Required: If the tax rate is 30 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).)

Explanation / Answer

Answer: Calculation of IRR:

First we calculate the annual depreciation of the new equipment.It will be:

Annual Depreciation charge=$636000/6=$106000

the after tax salvage value of the equipment is:

After tax salvage value=$43000(1-0.30)=$30100

Using the tax shield approach,the OCF is:

OCF=$163000(1-0.30)+0.30*106000=$114100+31800=$145900

NPV=0=-$636000+$38000+$145900(PVIFAr%,6)+[(30100-38000)/(1+IRR)6]

IRR=11.87%

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