Question

"A firm is considering purchasing a computer system. -Cost of system is $199,000. The firm will pay for the computer system in year 0. -Project life: 5 years -Salvage value in year 0 (constant) dollars: $17,000 -Depreciation method: five-years MACRS -Marginal income-tax rate = 40% (remains constant over time) -Annual revenue = $144,000 (year-0 constant dollars) -Annual expenses (not including depreciation) = $91,000 (year-0 constant dollars) If the general inflation rate is 4.1% during the project period (which will affect all revenues, expenses, and the salvage value but not depreciation), determine the INFLATION-FREE IRR' of the computer system. Enter your answer as a percentage between 0 and 100."

Answer 1

IRR is rate at which NPV comes to 0

Particulars	0	1	2	3	4	5	NPV
Cost of system	-199000
Annual revenue		149904.00	156050.06	162448.12	169108.49	176041.94
Annual expense		94731.00	98614.97	102658.18	106867.17	111248.72
Depreciation(WN 1)		39800.00	63680.00	38208.00	22924.8	22924.80
PBT		15373.00	-6244.91	21581.93	39316.52	41868.41
TAX @ 40%		-6149.20	2497.96	-8632.77	-15726.61	-16747.37
PAT		9223.8	-3746.9	12949.2	23589.9	25121.0
Add: depreciation		39800.00	63680.00	38208.00	22924.80	22924.80
Annual cash flow		49023.80	59933.06	51157.16	46514.71	48045.85
Salvage value(WN 2)						17054.59
Total cash flow	-199000	49023.80	59933.06	51157.16	46514.71	65100.44
PVIF @11.0955%	1	0.90012647	0.81022766	0.72930736	0.6564689	0.590905
Present value	-199000	44127.6199	48559.4194	37309.2926	30535.459	38468.175	0

Thus IRR = 11.0955%

Wn 1) Statement showing depreciation

Year	Opening balance	Depreciation rates	Depreciation	Closing balnce
1	199000	20.00%	39800	159200
2	159200	32.00%	63680	95520
3	95520	19.20%	38208	57312
4	57312	11.52%	22924.8	34387.2
5	34387.2	11.52%	22924.8	11462.4
6	11462.4	5.76%	11462.4	0

WN 2) Statement showing cash inflow of salvage value

Particulars	Amount
Salvage value(17000*1.041^5)	20782.721
Less BV as on date	11462.4
Profit	9320.321
Tax @ 40%	3728.1284
Cash inflow(20782.721-3728.1284)	17054.5926