Question

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $176,600 a year. The project will require new equipment costing $598,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $181,000 at the end of the project. The project requires an initial investment of $42,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

Answer 1

Initial Investment = Cost of New Equipment + Investment in NWC = $598,000 + $42,000 = $640,000

OCF(year 1 - 4) = $176,600

After-tax Salvage Value = $181,000 x (1 - 0.35) = $117,650

OCF(year 5) = Annual OCF + After-tax Salvage Value + Recovery of investment in NWC

= $176,600 + $117,650 + $42,000 = $336,250

To find the IRR, we need to put the following values in the financial calculator:

CF0 = -640,000; C01 = 176,600; F01 = 4; C02 = 336,250; F02 = 1; Press IRR, then CPT, which gives 16.87

Hence, Project's IRR is 16.87%.