Question

1. Assume the following for a firm that will operate for only three years. Year Zero: Capital Investment = $4M and increase in NWC = $0.2M; Years 1-3: NI = $3M, Depreciation =

$0.1M, Interest expense = $0.1M; Year 3: Recovery of earlier increase in NWC (i.e., decrease NWC by $0.2M), and in addition Cash Flow from Salvage = $3M. Suppose the tax rate is 30% for the firm. What is the IRR based on the FCFs for this firm in years 0 through 3?

1. 79.03%
2. 35.85%
3. 71.26%
4. 41.84%

Answer 1

C2 X for year o с year 0 year 1 $3,000,000 $ 100,000 $ 70,000 year 2 $3,000,000 $100,000 $70,000 year 3 $3,000,000 $100,000 $70,000 net income deprciation interest (net of tax) capital investment increase in NWC Recovery of earlier increase in NWC Cash Flow from Salvage free cash flow -$4,000,000 -$ 200,000 $ 200,000 $3,000,000 $6,370,000 -$4,200,000 $3,170,000 $3,170,000 Internal Rate of Retuern (IRR) = 71.26% hence, the correct answer is C. 71.26%

for formulas and calculations, refer to the image below -

X for year o A year 0 year 1 3000000 100000 =100000*0.7 year 2 3000000 100000 =100000*0.7 year 3 3000000 100000 =100000*0.7 net income deprciation interest (net of tax) capital investment increase in NWC Recovery of earlier increase in NWC Cash Flow from Salvage free cash flow -4000000 -200000 200000 3000000 =SUM(D3:09) =SUM(E3:E9) =SUM(F3:F9) =SUM(C3:09) Internal Rate of Retuern (IRR) = FIRR(C10:F10) hence, the correct answer is C. 71.26%

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