Question

Your firm is contemplating the purchase of a new $395,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will save $125,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 21 percent, what is the IRR for this project? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) IRR %

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-395000
Initial working capital		-35000
=Initial Investment outlay		-430000
Savings			125000	125000	125000	125000	125000
-Depreciation	Cost of equipment/no. of years		-79000	-79000	-79000	-79000	-79000
=Pretax cash flows			46000	46000	46000	46000	46000
-taxes	=(Pretax cash flows)*(1-tax)		36340	36340	36340	36340	36340
+Depreciation			79000	79000	79000	79000	79000
=after tax operating cash flow			115340	115340	115340	115340	115340
reversal of working capital							35000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						23700
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							58700
Total Cash flow for the period		-430000	115340	115340	115340	115340	174040
Discount factor=	(1+discount rate)^corresponding period	1	1.136758643	1.292220212	1.468942495	1.6698331	1.8981972
Discounted CF=	Cashflow/discount factor	-430000	101463.9305	89257.23255	78519.07096	69072.772	91686.997
NPV=	Sum of discounted CF=	0.00
IRR is discount rate at which NPV = 0 =	14.00%