ABC Inc. has provided the following data concerning a proposed project of buying
ID: 2380967 • Letter: A
Question
ABC Inc. has provided the following data concerning a proposed project of buying new machinery:
Initial Investment $851,000
Annual cash receipts $423,000
Life of the project 7 years
Annual cash expenses $169,000
Salvage value $65,000
The company's tax rate is 20%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of 13%.
Required:
Compute the net present value of the project and the Internal Rate of Return.
Explanation / Answer
Hi,
Please find the answer as follows:
Initial Cash Flow = -851000
Annual Cash Inflow = (Annual Cash Receipts - Annual Cash Expenses - Depreciation)*(1 - tax rate) + Depreciation
Annual Cash Inflow = (423000 - 169000 - 851000/7)*(1-.20) + 851000/7 = 227514.29
Final Year Cash Inflow = Annual Cash Inflow + Salvage Value After Tax = 227514.29 + 65000*(1 - .20) = 279514.29
NPV = -851000 + 227514.29/(1+.13)^1 + 227514.29/(1+.13)^2 + 227514.29/(1+.13)^3 + 227514.29/(1+.13)^4 + 227514.29/(1+.13)^5 + 227514.29/(1+.13)^6 + 279514.29/(1+.13)^7 = 177310.23
Part B: IRR
To calculate IRR, you need to put the value of NPV as 0 and solve for r as follows:
NPV = 0 = -851000 + 227514.29/(1+r)^1 + 227514.29/(1+r)^2 + 227514.29/(1+r)^3 + 227514.29/(1+r)^4 + 227514.29/(1+r)^5 + 227514.29/(1+r)^6 + 279514.29/(1+r)^7
Solving for r, we get IRR as : 19.31%
IRR = 19.31%
Thanks.