Question

"A firm is undertaking a project with the following details provided.

- The project costs $2.5 million and has a 7-year service life.

- It generates revenues of $560,000 annually.

- The project is classified as a 7-year property under the MACRS rule.
- At the end of year 7, any assets for the project will be sold. The expected salvage will be 18% of the initial $2.5M project cost.

- The firm will finance 40% of the project money from an outside source with an interest rate of 12%. The firm is required to repay the loan with 5 equal annual payments.

- The firm's tax rate is 21%.

- MARR is 16%.

Given this information, compute the IRR for this project. Enter your answer as percentage rounded to the nearest tenth of a percent (i.e., 8.3% is entered as 8.3)."

Answer 1

cost of system		-2500000
Annual depreciation
year	cost of machine	MACRS rate	Annual depreciation
1	2500000	14%	357250
2	2500000	24%	612250
3	2500000	17.49%	437250
4	2500000	12.49%	312250
5	2500000	8.93%	223250
6	2500000	8.92%	223000
7	2500000	8.93%	223250
year	0	1	2	3	4	5	6	7
cost of machine	-2500000
annual revenue		560000	560000	560000	560000	560000	560000	560000
depreciation		357250	612250	437250	312250	223250	223000	223250
operating profit		202750	-52250	122750	247750	336750	337000	336750
after tax profit = operating profit*(1-tax rate)		160172.5	-41277.5	96972.5	195722.5	266032.5	266230	266032.5
add depreciation		357250	612250	437250	312250	223250	223000	223250
after tax sale proceed = sale value*(1-tax rate)		0	0	0	0	0	0	378915
net operating cash flow = after tax profit+ Depreciation +after tax sales value	-2500000	517422.5	570972.5	534222.5	507972.5	489282.5	489230	868197.5
IRR = Using IRR function in MS excel	IRR(D2416:K2416)	12.5
Book value of machine at the end of 7th year	cost of machine*macrs rate at year 8th	2500000*4.46%	111500
sale value		2500000*18%	450000
gain on sale	450000-111500	338500
tax on gain	338500*21%	71085
after tax sale proceeds	450000-71085		378915