Answer:
14.29%
Explanation:
Calculation of the IRR for this project
First step is to find the depreciation
Each year depreciation will be :
$485,000/5=$97,000
Second step is to calculate for the Operating Cash flow for each year
Using this formula
Each year OCF=(Sales-costs)*(1-Tc)+Depreciation*Tc
=$140,000*76%+$97,000*24%=$129,680
Therefore in n five years, the after-tax salvage will be calculated as:
$35,000-($35,000-0)*Tc=$26,600
Hence in year 5, total cash flow will be:
=$129,680-$60,000+$26,600=$96,280
For the year 0, the total cash flow i will be:
-$485,000+$60,000=-$425,000
Last step is to find the NPV
Let NPV=-$425,000+$129,680/(1+IRR)^¹+ $129,680/(1+IRR)^²+ $129,680/(1+IRR)^3+$129,680/(1+IRR)^⁴+ $96,280/(1+IRR)⁵=0
IRR=14.29%
Therefore the IRR for this project will be 14.29%
The IRR for this project can be calculated using an excel function as done in the attached photo.
In the attached photo, the net cash flow is first calculated and the following formulae are used:
After tax annual savings = Annual savings * (100% - Tax rate) = $140,000 * (100% - 24%) = $106,400
Tax shield on depreciation = (Machine cost * Tax rate) / Machine year life = ($485,000*24%) / 5 = $23,280
After tax sale value = Working capital reduction * (100% - Tax rate) = $60,000 * (100% - 24%) = $45,600
In the attached photo, the IRR for is calculated by using the Excel IRR function by simply typing "IRR((C9:H9)" in any cell in this sheet. "(C9:H9)" implies that the relevant data are the net cash flow from cells C9 to H9 in the particular excel sheet.
From the attached excel file, the IRR for this project is therefore 15.26%.
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