Iron Ore Company Ltd. (IOC) is considering buying a new truck so that it can make its own deliveries. The truck will cost $150,000, has a life expectancy of five years and is expected to save the company $45,000 before tax each year in delivery expenses. IOC’s cost of capital is 9%, and its tax rate is 24%. Ignoring CCA and salvage, what is the payback period (PBP) and internal rate of return (IRR) for the proposed purchase? a) PBP = 3.33 years; IRR = 15.24% b) PBP = 4.39 years; IRR = 4.53% c) PBP = 4.39 years; IRR = 9.00% d) PBP = 5.83 years; IRR = 4.53%
Payback period = Cost of truck/Annual Savings after tax
= $150,000/45,000(1-0.24)
= 4.39 years
IRR is the rate at which NPV = 0
Let the IRR be x
0 = 45,000*(1-0.24)*PVAF(x%, 5 years) – 150,000
= 34,200*PVAF(x%, 5 years) – 150,000
PVAF(x%, 5 years) = 4.386
From Present value annuity factor table,
PVAF(4%, 5 years)= 4.4518
PVAF(5%, 5 years) = 4.3295
Using interpolation technique, IRR = 4% + (4.4518-4.386)/(4.4518 – 4.3295)
= 4.53%
Hence, the answer is b) PBP = 4.39 years; IRR = 4.53%
Iron Ore Company Ltd. (IOC) is considering buying a new truck so that it can make...