Question

The Michener Company purchased a special machine 1 year ago at a cost of $12,000. At that time, the machine was estimated to have a useful life of 6 years and no disposal value. The annual cash operating cost is approximately $20,000. A new machine that has just come on the market will do the same job but with an annual cash operating cost of only $17,000. This new machine costs $15,000 and has an estimated life of 5 years with no disposal value. The old machine could be used as a trade-in at an allowance of $5,000. Straight-line depreciation is used and the company’s income tax rate is 40 percent.
Compute the internal rate of return on the new investment.

Answer 1

Year	Incremental Cash Outflow	Old Operating Cost	New Operating Cost	Savings in Cost	Depreciation on Old machine	Depreciation on New machine	Incremental depreciation	Net Profit	Tax @ 40%	CFAT
	A	B	C	D=B-C	E=12000/6	F=15000/5	G=F-E	H=D-G	I=H*40%	J=H-I+G+A
-	-10,000	-	-	-	-	-	-	-	-	-10,000
1	-	20,000	17,000	3,000	2,000	3,000	1,000	2,000	800	2,200
2	-	20,000	17,000	3,000	2,000	3,000	1,000	2,000	800	2,200
3	-	20,000	17,000	3,000	2,000	3,000	1,000	2,000	800	2,200
4	-	20,000	17,000	3,000	2,000	3,000	1,000	2,000	800	2,200
5	-	20,000	17,000	3,000	2,000	3,000	1,000	2,000	800	2,200
									IRR	3.26%

1. To calculated IRR, find this in excel, Formula= IRR(-10000, 2200, 2200, 2200, 2200, 2200) .

2. No capital gain tax on old vehicle sale has been considered due to absence of capital gain tax rate information.

3. Savings in cost is considered as Cash Inflow.

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