Your firm is contemplating the purchase of a new $542,500 computer-based order e

Question

Your firm is contemplating the purchase of a new $542,500 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $48,000 at the end of that time. You will save $168,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $43,000 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 40 percent, what is the IRR for this project?

Explanation / Answer

Description of item Y0 Y1 Y2 Y3 Y4 Y5 Initial Investment (A) -542500 Cash flow from savings after tax=(1-0.34)*168000 (B) 110880 110880 110880 110880 110880 Depriciation taxShield=0.34*(542500/5) © 36890 36890 36890 36890 36890 Salvage Value after tax=(1-0.34)*48000 (D) 31680 Working Capital (E) 43000 -43000 Net Cash Flow=A+B+C+D+E -499500 147770 147770 147770 147770 136450 So, -499500+147770/(IRR^1)+147770/(IRR^2)+147770/(IRR^3)+147770/(IRR^4)+136450/(IRR^5)=0 By trial and error , we get the IRR=14.16% (appx)

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