Question

The managers of Poncho Parts, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next 5 years. The necessary foundry and machining equipment will cost a total of $800,000. This amount will be depreciated on a straight-line basis to zero over the project's life. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labor and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.

Assume that management believes that auto restorers will pay $3,000 retail per engine block.

What is the IRR of the above project?

a- 39.53%

b- 31.12%

c- 47.57%

d- 51.28%

e- 56.60%

Answer 1

OPTION A is right

The Annual operating cash flows are as below
OCF					SL
Year	Sales	Labour and material	Fixed cost	Depreciation	EBIT	Tax	PAT	OCF
0
1	750000	125000	125000	160000	340000	119000	221000	381000
2	750000	125000	125000	160000	340000	119000	221000	381000
3	750000	125000	125000	160000	340000	119000	221000	381000
4	750000	125000	125000	160000	340000	119000	221000	381000
5	750000	125000	125000	160000	340000	119000	221000	381000

The net cash flows are

Net Cash flows
Year	Initial cost	OCF	Salvage after tax	Net CF
0	-800000			-800000
1		381000		381000
2		381000		381000
3		381000		381000
4		381000		381000
5		381000	97500	478500
			IRR	39.53%

WORKINGS