Question

Caspian Sea Drinks is considering the purchase of a new water filtration system produced by Rube Goldberg Machines. This new equipment, the RGM-7000, will allow Caspian Sea Drinks to expand production. It will cost $15.00 million fully installed and will be fully depreciated over a 15 year life, then removed for no cost. The RGM-7000 will result in additional revenues of $3.32 million per year and increased operating costs of $704,891.00 per year. Caspian Sea Drinks' marginal tax rate is 28.00%. The internal rate of return for the RGM-7000 is _____.

Answer 1

Annual Depreciation = Cost/Life

= 15,000,000/15

= $1,000,000

IRR is the rate at which NPV = 0

Let it be x

NPV = Present value of cash inflows – Present value of cash outflows

0 = [(3,320,000-704,891-1,000,000)(1-28%)+1,000,000]*PVAF(x%, 15 years) – 15,000,000

0= 2,162,878.48*PVAF(x%, 15 years) -15,000,000

PVAF(x%, 15 years) = 6.9352

Using PVAF table, PVAF(11%, 15 years) = 7.1909

PVAF(12%, 15 years) = 6.8109

Using interpolation, x = 11% + (7.1909-6.9352)/(7.1909-6.8109)

= 11.67%

Hence, IRR = 11.67%