Question

Robinson Corporation currently processes seafood with a machine it purchased several years ago. The machine, which originally cost $1,000,000, currently has a book value of $400,000. Robinson is considering replacing the machine with a newer, more efficient one. The new machine will cost $1,400,000 and will require an additional $100,000 for delivery and installation. The new machine will also require Robinson to increase its investment in receivables and inventory by $400,000. The new machine will be depreciated on a straight-line basis over five years to a zero balance. Robinson expects to sell the existing machine for $300,000. Robinson’s marginal tax rate is 25 percent and the required rate of return for Robinson is 12 percent.

                        If Robinson purchases the new machine, annual revenues are expected to increase by $200,000 and annual operating costs (exclusive of depreciation) are expected to decrease by $50,000. Annual revenue and operating costs are expected to remain constant at this new level over the five-year life of the project. After five years, the new machine will be completely depreciated and is expected to be sold for $200,000. (Assume that the existing unit is being depreciated at a rate of $80,000 per year.)

1. Determine the internal rate of return of the project.

Answer 1

CASH OUTFLOW
New Machine Cost	14,00,000.00
+ Delivery and Installation Expenses	1,00,000.00
+ Increase in Working Capital	4,00,000.00
- Sale sale of old machine	3,00,000.00
Net investment	16,00,000.00
PARTICULAR	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5
Increase in Revenue for five years	1,50,000.00	1,50,000.00	1,50,000.00	1,50,000.00	1,50,000.00
Decrease in cost	37,500.00	37,500.00	37,500.00	37,500.00	37,500.00
Increase in Depreciation	1,65,000.00	1,65,000.00	1,65,000.00	1,65,000.00	1,65,000.00
Salavge Value of Machine					2,00,000.00
Working Capital					4,00,000.00
CASH INFLOW	3,52,500.00	3,52,500.00	3,52,500.00	3,52,500.00	9,52,500.00
PVIF @12%	0.892857143	0.797193878	0.711780248	0.635518078	0.567426856
PV	314732.1429	281010.8418	250902.5374	224020.1226	540474.0801
TOTAL PV	16,11,139.72
CASH OUTFLOW	16,00,000.00
NET CASH FLOW	11,139.72
Increase in Revenue
Return	2,00,000.00
Tax on Return	50,000.00
Net Saving	1,50,000.00
Decrease in Cost
Cost Saving	50,000.00
Tax	12,500.00
Net Saving	37,500.00
Saving in Depreciation
New Depreciation	3,00,000.00	(machine cost $14,00,000 + Insatllation Cost $1,00,000)/life 5 years
Old Depreciation	80,000.00
Increase in Deprication	2,20,000.00
Tax on depreciation	55,000.00
Net Saving due to depreciation	1,65,000.00
CALCULATION OF IRR ASSUME 13% RATE
NPV =	INFLOW -OUTFLOW
NPV =	352500/1.13	+ 352500/1.13^2	+352500/1.13^3	+352500/1.13^4	+ 952500/1.13^5	-1600000
NPV =	15,65,480-16,00,000
	-34520
NPV
AT 12%	11140
AT 13%	-34520
CHANGE
1%	45660
NPA REQUIRED "0"
IRR =	12 % +	(11140-0)
		(11140-34520)
=	12 % +	0.243977223
=	12.24%
CHECK
INFLOW	352500	352500	352500	352500	952500
PV @ 12.24%	0.890947969	0.793788283	0.707224058	0.630099838	0.561386171
PV	314059.1589	279810.3697	249296.4805	222110.1929	534720.3275
TOTAL PV (ROUND)	1600000
OUTFLOW	1600000
NET PV	0