Cirice Corp. is considering opening a branch in another state. The operating cas
ID: 2811340 • Letter: C
Question
Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $154,200 a year. The project will require new equipment costing $601,000 that would be depreciated on a straight-line basis to zero over the 6-year life of the project. The equipment will have a market value of $183,000 at the end of the project. The project requires an initial investment of $42,500 in net working capital, which will be recovered at the end of the project. The tax rate is 40 percent. What is the project's IRR?
Explanation / Answer
(1) Depreciation = 601000 / 6 years = 100,167
(2) Initial Investment = 601,000 + 42500 = 643,500
(3) In the sixth Year ( last year of project ) additional cashflows = 42500 working capital recovery + market valuue of project ( net of tax ) ...... 183000 * (1-0.40) = 42500 + 109800 = 152300
(4) Annual cash flows are calculated as under
Calculation of IRR
Now we can determine the IRR using the simple interpolation technique
10 % .............. 19919
X% ................ 0
11% ............... - 1161
( X - 10 ) / (11 - 10) = ( 0 - 19919 ) / ( - 1161 - 19919 )
X - 10 = - 19919 / -21080
X - 10 = 0.94
X = 10.94 % ........... is the IRR of the given project
Operating cash flow 154200 (-) Depreciation 100167 Profit before tax 54033 (-) Tax @ 40% 21613.2 Profit after tax 32419.8 (+) Depreciation 100167 Cash flow after tax 132586.8