Question

McGilla Golf has decided to sell a new line of golf clubs. The length of this project is seven years. The company has spent $1110000 on research and development for the new clubs. The plant and equipment required will cost $28600369 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1298967 that will be returned at the end of the project. The OCF of the project will be $8911665. The tax rate is 32 percent. What is the IRR for this project?

Answer 1

Research and development cost is not considered in project evaluation as it is considered as a sunk cost.

a. Initial cash outlay = purchase cost+training cost+increase in working capital.

=$28600369+$1298967
=$29,899,336

b. Cash flow from year 1 to 6 (CF1 to CF6) = [(OCF) x (1-tax rate)]+tax shield due to depreciation.

=[($8911665) x (1-0.32)]+ (28,600,369 x 0.32)/7
=$7,367,377.64 (B)

c. Cash flow for year 7= B+release of working capital.
=$7,367,377.64+$1298967
= $8,666,344.64

d. IRR: It is the discount rate at which the present value of projects cash outflows (cost) is equal to the present value of projects cash inflow.

{[$7,367,377.64/(1+IRR)^1]+[$7,367,377.64/(1+IRR)^2]+[$7,367,377.64/(1+IRR)^3]+[$7,367,377.64/(1+IRR)^4]+[$7,367,377.64/(1+IRR)^5]+[$7,367,377.64/(1+IRR)^6]+[$8,666,344.64/(1+IRR)^7]}= $29,899,336

IRR= 16.35%