Question

In: Finance

Your firm is contemplating the purchase of a new $1,344,000 computer-based order entry system. The system...

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?

Solutions

Expert Solution

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


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