Question

A project will require $511,800 for manufacturing equipment. The equipment is classified as five-year property for MACRS. The project has a three-year life. At the end of the project, the equipment will be worth about 20 percent of what we paid for it. We will have to invest $47,000 in net working capital at the start. After that, net working capital requirements will be 10 percent of sales. All additional investments in net working capital will be recovered at the end of the project. The project is expected to generate annual sales of $965,000 and costs of $508,000. The tax rate is 21 percent and the required rate of return is 14.7 percent. What is the project's IRR?

38.74%

28.36%

45.61%

51.92%

22.69%

Should this project be accepted?

Answer 1

Time line		0	1	2	3
Cost of new machine		-511800
Initial working capital		-47000
=Initial Investment outlay		-558800
5 years MACR rate			20.00%	32.00%	19.20%
Sales			965000	965000	965000
Profits	Sales-variable cost	457000	457000	457000
-Depreciation	=Cost of machine*MACR%	-102360	-163776	-98265.6
-working capital to be maintained			-96500	-96500	-96500
=Pretax cash flows			258140	196724	262234.4
-taxes	=(Pretax cash flows)*(1-tax)	203930.6	155411.96	207165.176
+Depreciation			102360	163776	98265.6
=after tax operating cash flow			306290.6	319187.96	305430.78
reversal of working capital					336500
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)			80864.4
+Tax shield on salvage book value	=Salvage value * tax rate			30953.664
=Terminal year after tax cash flows					448318.06
Total Cash flow for the period		-558800	306290.6	319187.96	753748.84
Discount factor=	(1+discount rate)^corresponding period	1	1.513933166	2.291993631	3.469925174
Discounted CF=	Cashflow/discount factor	-558800	202314.4792	139262.1496	217223.37
NPV=	Sum of discounted CF=	0.00
IRR is discount rate at which NPV = 0 =	51.92%

Accept project as IRR is greater than required rate