Your firm is contemplating the purchase of a new $610,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $610,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $66,000 at the end of that time. You will save $240,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $81,000 (this is a one-time reduction). If the tax rate is 35 percent, what is the IRR for this project? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What is the IRR?

Explanation / Answer

Calculation of annual net cash inflows:

Annual depreciation is 610,000 -66,000 /5 = $ 108,800

Net savings before taxes is 240,000

Net savings after taxes 240,000 ( 1- 0.35) = $ 156,000

Average net cash inflows 156,000 +108,800 = $ 264,800

Initial net investment is 610,000 -66,000 + 81,000 = $ 625,000

PV factor = Net investment in the project / average cash inflows = 625,000 / 194.080= 2.360

At 5 years, this PV factor corresponds to an IRR of approximately 31.5%

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