Your firm is contemplating the purchase of a new $542,500 computer-based order e
ID: 2761526 • 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).)
If you get these answers:
14.16%
16.01%
16.68%
12.75%
then your answer is incorrect!!
Explanation / Answer
Initial investment = 542,500- 43,000
= 499,500
Annual depreciation tax shield = depreciation x tax rate
= (542,500 -0)/5 x 40%
= 43,400
Annual cash flow = before tax savings x (1- tax rate) + depreciation tax shield
= 168,000 x (1-0.40) +43400
= 144,200
Net salvage value = 48000 x (1-0.40) =28,800
year
Cash flow
0
-499500
1
144200
2
144200
3
144200
4
144200
5
144200
5
-14200
IRR using IRR function in excel:
=IRR( cash flows)
IIRR= 13.07%
year
Cash flow
0
-499500
1
144200
2
144200
3
144200
4
144200
5
144200
5
-14200
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