Question

Assume that you are a vending machine dealer. You plan to purchase a vending machine for $200,000. One year later, you are expected to sell it back and receive $224,000 as cash. What is the IRR (internal rate of return) on this investment? Be sure to apply the definition of IRR and show your work.

3 points>

In order to buy the vending machine, you plan on borrowing $80,000 from Bank at 5% of interest rate and raise $120,000 from investors at 10% of cost of equity, are you going to accept this project? Why? (Tax rate is 30%). Show your work.

Answer 1

IRR is that Discount rate, at which NPV is 0      
      
Investment=   200000  
present value of cash flows = Cash flows/(1+i)^n      
n=1      
NPV = Present Value of cash flow - Investment      
0 = (224000/(1+i)^1)-200000      
200000= 224000/(1+i)      
(1+i)= 224000/200000      
i=   1.12   -1
0.12   or 12%  
      
So internal rate of return is 12%      
      
Debt amount=   80000  
Loan rate=   5%  
tax rate=   30%  
Equity amount=   120000  
cost of Equity=   10%  
      
WACC = ((weight of debt * cost of debt*(1-tax rate)) + (weight of equity * cost of equity))/Total weight      
((80000*5%*(1-30%))+(120000*10%))/(80000+120000)      
7.40%      
      
WACC is 7.40%. IRR is more than wacc, so we are going to accept the project      

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