Question

Your firm is contemplating the purchase of a new $590,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $77,000 at the end of that time. You will save $182,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $92,000 (this is a one-time reduction). If the tax rate is 23 percent.

what is the IRR for this project? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $590,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $590,000 / 5
Annual Depreciation = $118,000

Initial Investment in NWC = -$92,000

Salvage Value = $77,000

After-tax Salvage Value = $77,000 * (1 - 0.23)
After-tax Salvage Value = $59,290

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $182,000 * (1 - 0.23) + 0.23 * $118,000
Annual Operating Cash Flow = $167,280

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$590,000 + $92,000
Net Cash Flows = -$498,000

Year 1 - Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $167,280

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $167,280 - $92,000 + $59,290
Net Cash Flows = $134,570

Let IRR be i%

NPV = -$498,000 + $167,280/(1+i) + $167,280/(1+i)^2 + $167,280/(1+i)^3 + $167,280/(1+i)^4 + $134,570/(1+i)^5
0 = -$498,000 + $167,280/(1+i) + $167,280/(1+i)^2 + $167,280/(1+i)^3 + $167,280/(1+i)^4 + $134,570/(1+i)^5

Using financial calculator, i = 18.98%

IRR of the project = 18.98%