Question

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $187,600 a year. The project will require new equipment costing $580,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $169,000 at the end of the project. The project requires an initial investment of $39,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

Multiple Choice

• 20.13%

• 19.04%

• 16.93%

• 21.84%

• 22.14%

Answer 1

Answer is 20.13%

Initial Investment = $580,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $580,000 / 5
Annual Depreciation = $116,000

Initial Investment in NWC = $39,000

Salvage Value = $169,000

After-tax Salvage Value = $169,000 * (1 - 0.35)
After-tax Salvage Value = $109,850

Annual Operating Cash Flow = $187,600

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$580,000 - $39,000
Net Cash Flows = -$619,000

Year 1 to Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $187,600

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $187,600 + $39,000 + $109,850
Net Cash Flows = $336,450

Let IRR be i%

NPV = -$619,000 + $187,600/(1+i) + $187,600/(1+i)^2 + $187,600/(1+i)^3 + $187,600/(1+i)^4 + $336,450/(1+i)^5
0 = -$619,000 + $187,600/(1+i) + $187,600/(1+i)^2 + $187,600/(1+i)^3 + $187,600/(1+i)^4 + $336,450/(1+i)^5

Using financial calculator, i = 20.13%

IRR of the project is 20.13%