Question

Project Evaluation. Your firm is contemplating the purchase of a new $410,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will save $125,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 35 percent, what is the IRR for this project?

How do I enter this into my calculator?? Need help figuring out the npv( and irr( functions on my calculator!

Answer 1

Forecast the annual cash flows as shown below.

Order	0	1	2	3	4	5
Investment	-410,000
Salvage						30,000
NWC	35,000					-35,000
Savings		125,000	125,000	125,000	125,000	125,000
Depreciation		-82,000	-82,000	-82,000	-82,000	-82,000
EBT		43,000	43,000	43,000	43,000	43,000
Tax (35%)		-15,050	-15,050	-15,050	-15,050	-15,050
Net Income		27,950	27,950	27,950	27,950	27,950
Cash Flows	-375,000	109,950	109,950	109,950	109,950	94,450
IRR	13.37%

Depreciation = Investment / No. of years = 410,000 / 5 = 82,000

Cash Flows = Investment + NWC + Net Income + Depreciation + Salvage x (1 - tax)

Insert these cash flows in the financial calculator: CF0 = -375,000, CF1..CF4 = 109,950, CF5 = 94,450

=> Compute IRR = 13.37%