Your firm is contemplating the purchase of a new $660,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $660,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $51,000 at the end of that time. You will save $171,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $46,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

If the tax rate is 40 percent, what is the IRR for this project?

If the tax rate is 40 percent, what is the IRR for this project?

Explanation / Answer

Initial Investment (PV)= Purchase Cost - Decrease in Working Capial

Initial Investment (PV) = 660000 - 46000

Initial Investment (PV) = 614000

Terminal Value (FV) = Post tax salvage Value - Working Capital reverted

Terminal Value (FV) = 51000*(1-40%) - 46000

Terminal Value (FV) = - 15400

Annual cash Flow (PMT)= order processing costs Saving *(1-tax rate) + Annual Depreciation * tax rate

Annual cash Flow (PMT)=171000*(1-40%) + 660000/6 * 40%

Annual cash Flow (PMT)= $ 146,600

IRR = rate(nper,pmt,pv,fv)

IRR = rate(6,146600,-614000,-15400)

IRR = 10.88%

Answer

IRR = 10.88%

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