Question

Your firm is contemplating the purchase of a new $485,000 computer based order entry system. The system will depreciate straight line to zero over its five year life. It will be worth $35,000 at the end of that time. You will save $140,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $60,000(on time. If the tax rate is 24%, what is the IRR for this project?

Answer 1

Answer:

14.29%

Explanation:

Calculation of the IRR for this project

First step is to find the depreciation

Each year depreciation will be :

$485,000/5=$97,000

Second step is to calculate for the Operating Cash flow for each year

Using this formula

Each year OCF=(Sales-costs)*(1-Tc)+Depreciation*Tc

=$140,000*76%+$97,000*24%=$129,680

Therefore in n five years, the after-tax salvage will be calculated as:

$35,000-($35,000-0)*Tc=$26,600

Hence in year 5, total cash flow will be:

=$129,680-$60,000+$26,600=$96,280

For the year 0, the total cash flow i will be:

-$485,000+$60,000=-$425,000

Last step is to find the NPV

Let NPV=-$425,000+$129,680/(1+IRR)^¹+ $129,680/(1+IRR)^²+ $129,680/(1+IRR)^3+$129,680/(1+IRR)^⁴+ $96,280/(1+IRR)⁵=0

IRR=14.29%

Therefore the IRR for this project will be 14.29%