Question

What is the IRR of a project with the following characteristics?

Initial investment is $2,000,000

Initial investment is depreciated to $0 book value via straight-line over its 12 year life

Project is expected to generate incremental sales of 1,900,000 per year, and incremental expenses of 1,400,000 per year

There are no NWC or salvage cash flows

The firm faces a 28% tax rate

Answer 1

Initial Investment = $2,000,000
Useful Life = 12 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $2,000,000 / 12
Annual Depreciation = $166,666.667

Incremental OCF = (Incremental Sales - Incremental Costs) * (1 - Tax Rate) + Tax Rate * Depreciation
Incremental OCF = ($1,900,000 - $1,400,000) * (1 - 0.28) + 0.28 * $166,666.667
Incremental OCF = $500,000 * 0.72 + 0.28 * $166,666.667
Incremental OCF = $406,666.667

Let IRR be i%

NPV = -$2,000,000 + $406,666.667 * PVIFA(i%, 12)
0 = -$2,000,000 + $406,666.667 * PVIFA(i%, 12)

Using financial calculator:
N = 12
PV = -2000000
PMT = 406666.667
FV = 0

I = 17.35%

IRR of the project is 17.35%