Alt's is contemplating the purchase of a new $218,000 computer-based order entry system. The system will...

Alt's is contemplating the purchase of a new $218,000 computer-based order entry system. The system will be depreciated straight-line to zero over the system's five-year life. The system will be worth $20,000 at the end of five years. The company will save $73,500 before taxes per year and will reduce working capital by $15,800 at the beginning of the project. The net working capital will return to its original level when the project ends. The tax rate is 21 percent. What is the internal rate of return for this project?

1) What is the depreciation each year? 2) What is the amount of OCF each year? 3) What is the total cash inflow/outflow each year? 4) What is the IRR for this project?

Solutions

Expert Solution

depreciation each year = cost of system / depreciable life

depreciation each year = $218,000 / 5 = $43,600

Operating cash flow (OCF) each year = income after tax + depreciation

Operating cash flow (OCF) each year = $67,221

Total cash flows are calculated as below

In year 5, the working capital investment is restored to its original level.

profit on sale of system at end of year 5 = sale price - book value

book value is zero as the system is fully depreciated

after-tax salvage value = salvage value - tax on profit on sale of system

IRR is calculated using IRR function in Excel

IRR is 19.74%

jeff jeffy answered 1 year ago

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