Question

Your firm is contemplating the purchase of a new $688,800 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $61,500 at the end of that time. You will save $270,600 before taxes per year in order processing costs and you will be able to reduce working capital by $11,806 (this is a one-time reduction). If the tax rate is 35 percent, the IRR for this project is _____percent. (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-688800
Initial working capital		11806
=Initial Investment outlay		-676994
Savings			270600	270600	270600	270600	270600
-Depreciation	Cost of equipment/no. of years		-137760	-137760	-137760	-137760	-137760
=Pretax cash flows			132840	132840	132840	132840	132840
-taxes	=(Pretax cash flows)*(1-tax)		86346	86346	86346	86346	86346
+Depreciation			137760	137760	137760	137760	137760
=after tax operating cash flow			224106	224106	224106	224106	224106
reversal of working capital							-11806
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						39975
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							28169
Total Cash flow for the period		-676994	224106	224106	224106	224106	252275
Discount factor=	(1+discount rate)^corresponding period	1	1.202999953	1.4472089	1.7409922	2.0944136	2.5195794
Discounted CF=	Cashflow/discount factor	-676994	186289.2842	154853.94	128723.15	107001.79	100125.84
NPV=	Sum of discounted CF=	0.002060908
IRR is discount rate at which NPV = 0 =	20.30%