Your firm is contemplating the purchase of a new $542,500 computer-based order e
ID: 2761155 • Letter: Y
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? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Explanation / Answer
Calculation of IRR for the project:
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Purchase cost of system
$(542,500)
Reduction in working capital
$ 43,000
$ (43,000)
Saving due to tax on depreciation:
Depreciation = (Cost - Salvage value) / Life years
= (542500-48000) / 5 = 98900
Saving due to tax on depreciation = 98900*40% =
$ 39,560
$ 39,560
$ 39,560
$ 39,560
$ 39,560
Saving in in order processing costs (After Tax) = 168000*(1-40%)
$100,800
$100,800
$100,800
$100,800
$100,800
Salve value of system at the end (net of tax) =
$ 48,000
Net cash flows
$(499,500)
$140,360
$140,360
$140,360
$140,360
$145,360
IRR =
12.75%
Formula = IRR()
Calculation of IRR for the project:
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Purchase cost of system
$(542,500)
Reduction in working capital
$ 43,000
$ (43,000)
Saving due to tax on depreciation:
Depreciation = (Cost - Salvage value) / Life years
= (542500-48000) / 5 = 98900
Saving due to tax on depreciation = 98900*40% =
$ 39,560
$ 39,560
$ 39,560
$ 39,560
$ 39,560
Saving in in order processing costs (After Tax) = 168000*(1-40%)
$100,800
$100,800
$100,800
$100,800
$100,800
Salve value of system at the end (net of tax) =
$ 48,000
Net cash flows
$(499,500)
$140,360
$140,360
$140,360
$140,360
$145,360
IRR =
12.75%
Formula = IRR()
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