Your firm is contemplating the purchase of a new $794,500 computer-based order e

Question

Your firm is contemplating the purchase of a new $794,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $58,000 at the end of that time. You will save $178,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $53,000 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 35 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).) IRR %

Explanation / Answer

Initial investment = 794,500 -53000

                                    = 741,500

Annual depreciation = (794,500-0)/7 = 113,500

Year1 cash flow =( before tax saving – depreciation)x (1-t) + Depreciation

                                = (178,000-113,500) x (1-0.35) + 113,500

                                = 41925+113500

                                = $155,425

Last year cash flow= 155425 + 58000 x(1-0.35) -53000

                                     = 140,125

Year

Cash flow

0

-741500

1

155425

2

155425

3

155425

4

155425

5

155425

6

155425

7

140125

Now we can use irr function to compute internal rate of return.

= irr(cash flows)

IRR = 10.30%

Year

Cash flow

0

-741500

1

155425

2

155425

3

155425

4

155425

5

155425

6

155425

7

140125

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