In: Accounting
"A firm is considering purchasing a new milling machine and has
collected the following information for its income statement and
cash flow statement. However, this income statement was calculated
as if there is no inflation! All dollars are expressed in constant
(year0) dollars. Recalculate the income and cash flow statement by
assuming there is a general (average) inflation of 4.7% applied to
revenue, O&M, and salvage value.
 The firm will pay back the loan in 2 years, and the annual loan
payment is $15,796.
 The tax rate is 39%.
 The revenue for year 1 is $36,000 and $27,000 for year 2.
 O&M for year 1 is $12,000 and $13,500 for year 2.
 The interest paid on the debt is $2427 for year 1 and $1264 for
year 2.
 The taxable income is $12,713 for year 1 and $4,644 for year
2.
 The income taxes are $4,958 for year 1 and $1,811 for year
2.
 The milling machine costs $62,000.
 The salvage value at the end of year 2 is $47,000.
Calculate the IRR of the cash flow based on actual dollars. Express
your answer as a percentage between 0 and 100.
You should calculate the depreciation based on the information
given in the problem, but do not refer to the MACRS table. You will
also need to calculate the amount that is borrowed and that goes to
the principal on the debt in years 1 and 2."
Cash Flow statement 

Year 0 
Year 1 
Year 2 

1 
Sales revenue 
 
$37,692 
$28,269 

2 
O&M cost 
 
12,564 
14,135 

3 
Interest cost 
 
2,427 
1,264 

4 
Income before tax 
 
22,701 
12,871 

[1(2+3+4)] 

5 
Taxes at 39% 
 
4958 
4958 

6 
Net income 
 
17,743 
7,913 

[45] 
 

7 
Cash flow from operation 
 
17,743 
7,912.5 

[1235] 
 

8 
Initial Investment 
($62,000) 
 
 

9 
Salvage value 
47000 

10 
Total cash flow 
($62,000) 
$17,743 
$54,913 

[7+8+9] 
IRR Calculation
The calculation of IRR is based on Net Present Value (NPV) being zero, thus:
NPV = 0; or
PV of future cash flows − Initial Investment = 0; or
CF_{1} 
+ 
CF_{2} 
− Initial Investment = 0 

( 1 + r )^{1} 
( 1 + r )^{2} 
Where,
r is the internal rate of
return;
CF_{1} is the period one
net cash inflow;
CF_{2} is the period two
net cash inflow,
Assuming IRR at 12% 

PV(C_{0}) 
PV(C1) 
PV(C2) 

62000 
= 17743/(1.12)^1 
= 54913/(1.12)^2 

62000 
15842 
43776 

NPV {(PV(C_{0})+ PV(C_{0})+ PV(C_{0})} 
2382.1 

Since negative NPV let’s assume lower IRR of 10% 

PV(C_{0}) 
PV(C1) 
PV(C2) 

62000 
= 17743/(1.10)^1 
= 54913/(1.10)^2 

62000 
16130 
45382 

NPV 
487.77 

Since negative NPV let’s assume lower IRR of 9.5% 
PV(C_{0}) 
PV(C1) 
PV(C2) 
62000 
= 17743/(1.095)^1 
= 54913/(1.095)^2 

62000 
16204 
45798 

NPV 
1.28 

Since NPV is close to zero, IRR is 9.5% 
Principle payment 

Year 1 
Year 2 

Aggregate loan payment 
15796 
15796 
Interest Payment 
2,427 
1,264 
Principle payment 
13369 
14532 