Question

"A firm is considering purchasing a new milling machine and has collected the following information for its income statement and cash flow statement. However, this income statement was calculated as if there is no inflation! All dollars are expressed in constant (year-0) dollars. Recalculate the income and cash flow statement by assuming there is a general (average) inflation of 4.8% applied to revenue, O&M, and salvage value.
- The firm will pay back the loan in 2 years, and the annual loan payment is $12,815.
- The tax rate is 30%.
- The revenue for year 1 is $30,000 and $22,000 for year 2.
- O&M for year 1 is $9,000 and $11,900 for year 2.
- The interest paid on the debt is $1726 for year 1 and $894 for year 2.
- The taxable income is $10,843 for year 1 and $1,981 for year 2.
- The income taxes are $3,253 for year 1 and $594 for year 2.
- The milling machine costs $59,000.
- The salvage value at the end of year 2 is $47,000.
Calculate the IRR of the cash flow based on actual dollars. Express your answer as a percentage between 0 and 100.
You should calculate the depreciation based on the information given in the problem, but do not refer to the MACRS table. You will also need to calculate the amount that is borrowed and that goes to the principal on the debt in years 1 and 2."

Answer 1

To calculate the IRR we would need to adjust for inflation by multiplying the Rev & OM for 1st year by 1.048 & Rev, OM and Salvage value for 2nd year by 1.098 (1.048*1.048)

Answers:- IRR-18%

Depreciation - year 1 = 9,439 & Year 2 = 8,218

Amount borrowed :- 23,010 (can be rounded to 23,000)

Workings are below:-

	Year 1	Year 2
Revenue	31,440	24,163
Depreciation	9,439	8,218
O&M	9,432	13,070
EBIT	12,569	2,875
Interest Paid	1,726	894
Taxable income	10,843	1,981
income tax	3,253	594
net income	7,590	1,387
Loan Payment	12815	12815
Interest	1,726	894
Principal paid	11,089	11,921
Total Amount borrowed	23010
	0	1	2
cost of machine	-59000
Revenue		31,440	24162.69
Depreciation		9,439	8,218
Loan Payment		-12815	-12815
O&M		-9000	-11900
Salvage value			51620.29
Total	-59000	19064	59285.85
IRR	18%