Question

"A firm is considering purchasing a computer system.
-Cost of system is $198,000. The firm will pay for the computer system in year 0.
-Project life: 5 years
-Salvage value in year 0 (constant) dollars: $10,000
-Depreciation method: five-years MACRS
-Marginal income-tax rate = 40% (remains constant over time)
-Annual revenue = $147,000 (year-0 constant dollars)
-Annual expenses (not including depreciation) = $88,000 (year-0 constant dollars)
-The general inflation rate is 4.9% during the project period (which will affect all revenues, expenses, and the salvage value but not depreciation).
-The firm borrows the entire $198,000 at 14.9% interest to be repaid in 2 annual payments. The debt interest paid and the principal payment SHOULD NOT be changed by the inflation rate. Lending agencies set the interest rate of borrowing to account for the inflation rate.
Calculate the effects of borrowing and include the debt interest paid and the principal repayment into the income statement and cash flow statement. Determine the INFLATION-FREE IRR' of the computer system. Enter your answer as a percentage between 0 and 100."

Answer 1

Cost	198000
Life	5	Years
Salvage Value	10000
Depreciation	MACRS
Tax Rate	40%
Annual Revenue	147000
Annual Expense (excluding Dep)	88000
Inflation	4.90%
Interest Rate	14.90%
Repayment	2	Instalments
Calculation of Cash Inflows
		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Cash Outflows		-198000	0	0	0	0	0
Annual Revenue		0	154203	161758.9	169685.1	177999.7	186721.7
Less: Annual Expenses		0	92312	96835.29	101580.2	106557.6	111779
		0	61891	64923.66	68104.92	71442.06	74942.72
Less: Depreciation		0	39600	31680	25344	20275.2	16220.16
		0	22291	33243.66	42760.92	51166.86	58722.56
Less: Interest		0	29502	14751	0	0	0
		0	-7211	18492.66	42760.92	51166.86	58722.56
Less: Tax		0	-2884.4	7397.064	17104.37	20466.74	23489.02
PAT		0	-4326.6	11095.6	25656.55	30700.12	35233.54
Add: Depreciation		0	39600	31680	25344	20275.2	16220.16
Cash Inflows After Tax		0	35273.4	42775.6	51000.55	50975.32	51453.7
Add: Salvage Value at Year 5							10000
Net Cash Flows		-198000	35273.4	42775.6	51000.55	50975.32	61453.7
IRR		6.42%