Question

#2

Caspian Sea Drinks is considering the purchase of a new water filtration system produced by Rube Goldberg Machines. This new equipment, the RGM-7000, will allow Caspian Sea Drinks to expand production. It will cost $13.00 million fully installed and will be fully depreciated over a 15 year life, then removed for no cost. The RGM-7000 will result in additional revenues of $3.26 million per year and increased operating costs of $602,487.00 per year. Caspian Sea Drinks' marginal tax rate is 20.00%. The internal rate of return for the RGM-7000 is _____.

Can you please explain step by step without using Excel. Is it even possible to find the answer with a BA II calculator?

Answer 1

Solution :-

Depreciation Every Year = $13,000,000 / 15 = $866,666.67

Now Depreciation Tax Shield = Dep * Tax = $866,666.67 * 0.20 = $173,333.33

Net Cash flow from year 1 to 15 = Net After tax Annual Revenue + Dep  Tax shield

Net After tax Annual Revenue = ( $3,260,000 - $602,487 ) * ( 1 - 0.20 ) = $2,126,010.40

Now Cash flow Annually = $2,126,010.40 + $173,333.33 = $2,299,343.73

Now Find NPV at interest Rate 10 %

NPV = - $13,000,000 + $2,299,343.73 * PVAF ( 10% , 15 )

= - $13,000,000 + ( $2,299,343.73 * 7.606 )

= $4,488,991.22

Now Find NPV at interest Rate 20 %

NPV = - $13,000,000 + $2,299,343.73 * PVAF ( 20% , 15 )

= - $13,000,000 + ( $2,299,343.73 * 4.675 )

= - $2,249,481.29

Now IRR = 10% + [ $4,488,991.22 / ( $4,488,991.22 + $2,249,481.29 ) ] * ( 20% - 10% )

= 10% + 5.70%

= 15.70% ( Approx )

Therefore The internal rate of return for the RGM-7000 is 15.70%

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