Question

Your firm is contemplating the purchase of a new $1,344,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $120,000 at the end of that time. You will save $528,000 before taxes per year in order processing costs and you will be able to reduce working capital by $177,994 (this is a one-time reduction). Required : If the tax rate is 30 percent, what is the IRR for this project?

Answer 1

Year	Cash flows = CF	Depreciation = D = 1344000/5 = 268800	Working capital adjustment = WC	Net cash flow* = (CF-D)x(1-Tax rate)+D+WC	Discount factor = Df = 1/(1+18.0137%)^Year	Discounted cash flows = Net cash flow x Df
	CF	D	WC	(CF-D)x(1-Tax rate)+D+WC
0	(1,344,000)	-	(177,994)	(1,521,994)	1.0000	(1,521,994.00)
1	528,000	268,800		450,240	0.8474	381,515.03
2	528,000	268,800		450,240	0.7180	323,280.29
3	528,000	268,800		450,240	0.6084	273,934.54
4	528,000	268,800		450,240	0.5155	232,120.97
5	648,000	268,800	177,994	712,234	0.4369	311,143.38
			IRR =	18.0137%	Total =	0.20

Note:

1) Net Cash flow* for Year 0 = CF + WC

2) Cash flow at year 5 = $528000 + $120000

2) IRR calculation is trial and error method, we can get IRR by discounting all cash flows which makes sum of zero at year 0