Question

Your firm is contemplating the purchase of a new $570,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $86,000 at the end of that time. You will save $175,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $111,000 (this is a one-time reduction). If the tax rate is 22 percent, what is the IRR for this project? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $570,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $570,000 / 5
Annual Depreciation = $114,000

Initial Investment in NWC = -$111,000

Salvage Value = $86,000

After-tax Salvage Value = $86,000 * (1 - 0.22)
After-tax Salvage Value = $67,080

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual OCF = $175,000 * (1 - 0.22) + 0.22 * $114,000
Annual OCF = $161,580

Let IRR be i%

NPV = -$570,000 + $111,000 + $161,580 * PVIFA(i%, 5) + $67,080 * PVIF(i%, 5) - $111,000 * PVIF(i%, 5)
0 = -$459,000 + $161,580 * PVIFA(i%, 5) - $43,920 * PVIF(i%, 5)

Using financial calculator, i = 20.67%

IRR of the project is 20.67%