Question

"A firm is considering purchasing a computer system. The following data has been collected.
- Cost of the system: $159,000
- Project life: 6 years
- Salvage value at the end of year 6: $18,000
- Depreciation method: five-year MACRS
- Tax rate: 32%
- Annual revenue from project: $105,000
- Annual expenses (not including depreciation): $66,000
The firm will borrow the entire $159,000 at 7.4% interest to be repaid in 2 annual payments.
The firm's MARR is 12%. Determine the IRR for the computer system. Enter your answer as a percentage between 0 and 100."

Answer 1

	0	1	2	3	4	5	6
Annual revenue		105000	105000	105000	105000	105000	105000
Annual cash expenses		66000	66000	66000	66000	66000	66000
Depreciation MACRS		31800	50880	30528	18317	18317	9158
Incremental NOI		7200	-11880	8472	20683	20683	29842
Tax at 32%		2304	-3802	2711	6619	6619	9549
NOPAT		4896	-8078	5761	14065	14065	20292
Add: Depreciation		31800	50880	30528	18317	18317	9158
Annual operating cash flows		36696	42802	36289	32381	32381	29451
Capital expenditure	159000						-12240	[18000*(1-0.32)]
Annual project cash flows	-159000	36696	42802	36289	32381	32381	41691
CALCULATION OF IRR:								`
IRR is that discount rate for which the NPV = 0, or which makes PV of cash inflows equal to PV of cash outflows.
Such a discount rate is to be found out by trial and error, as done below:								TOTAL
Annual project cash flows	-159000	36696	42802	36289	32381	32381	41691
PVIFA at 10%	1	0.90909	0.82645	0.75131	0.68301	0.62092	0.56447
PV at 10%	-159000	33360	35373	27264	22117	20106	23533	2754
PVIFA at 11%	1	0.90090	0.81162	0.73119	0.65873	0.59345	0.53464
PV at 11%	-159000	33059	34739	26534	21331	19217	22290	-1831
NPV is positive at 10% and negative at 11%.
The exact value of IRR = 10+(2754/(2754+1831) =		10.60%
As the IRR is less than the MARR of 12%, the investment should not be made.