Question

Molly is considering opening a Campus Delivery business. The initial investment for the business is $263,000, which includes purchasing delivery vehicles and other investments. For tax purposes, the projected salvage value of the delivery vehicles is $25,000. The government requires depreciating the vehicles using the straight-line method over the business’s life of 10 years. Molly is trying to estimate the net cashflows after tax for this business. She has already figured out that the business will generate an annual after-tax cash inflow of $54,000 from the operation. She now needs your help to estimate the net cash inflow that she will receive from selling the delivery vehicles at the end of 10 years.

9Molly is very optimistic about the sale of the delivery vehicles, and thinks that the best-case scenario of selling them for $30,000 will happen. Under this assumption, what is the Internal Rate of Return (IRR) for Molly’s delivery business?

Multiple Choice

• 12.3%

• 18.5%

• 15.9%

• 16.4%

• 16.9%

Answer 1

Option D: 16.4%

Year	Particulars	Cash Flow	Present Value Factor @ 16%	Discounted Cash Flow @ 16%	Present Value Factor @ 18%	Discounted Cash Flow @ 18%
0	Investment	$ -2,63,000.00	1.0000	$ -2,63,000.00	1.0000	$ -2,63,000.00
1	Annual Cash Flow	$       54,000.00	0.8621	$       46,551.72	0.8475	$       45,762.71
2	Annual Cash Flow	$       54,000.00	0.7432	$       40,130.80	0.7182	$       38,781.96
3	Annual Cash Flow	$       54,000.00	0.6407	$       34,595.51	0.6086	$       32,866.07
4	Annual Cash Flow	$       54,000.00	0.5523	$       29,823.72	0.5158	$       27,852.60
5	Annual Cash Flow	$       54,000.00	0.4761	$       25,710.10	0.4371	$       23,603.90
6	Annual Cash Flow	$       54,000.00	0.4104	$       22,163.88	0.3704	$       20,003.30
7	Annual Cash Flow	$       54,000.00	0.3538	$       19,106.79	0.3139	$       16,951.95
8	Annual Cash Flow	$       54,000.00	0.3050	$       16,471.37	0.2660	$       14,366.06
9	Annual Cash Flow	$       54,000.00	0.2630	$       14,199.46	0.2255	$       12,174.63
10	Annual Cash Flow & Salvage Value	$       84,000.00	0.2267	$       19,041.42	0.1911	$       16,049.42
NET PRESENT VALUE	$         4,794.79		$     -14,587.41

Internal Rate of Return (IRR) = 16% + [ (18% - 16%) * ( $ 4,794.79 / ( $ 4,794.79 - ( - $ 14,587.41) ) ) ]

= 16% + ( 2% * 0.25 )

= 16.5% ( Approximately )

Note: Tax savings on depreciation is not considered since Tax rate is not provided.