Question

Your firm is contemplating the purchase of a new $485,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $35,000 at the end of that time. You will save $140,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $60,000 (this is a one-time reduction). If the tax rate is 24 percent, what is the IRR for this project?

Answer 1

The IRR for the project is approximately 12.67%.

Step-by-step explanation:

To calculate the Internal Rate of Return (IRR) for this project, we need to consider the cash inflows and outflows. The initial cash outflow is the cost of the system, which is $485,000. The cash inflows are the annual savings in processing costs and the reduction in working capital.

So, the cash inflows per year are $140,000 (savings in processing costs) and $60,000 (reduction in working capital). The cash inflow at the end of year 5 is $35,000 (residual value of the system).

Using these cash inflows and outflows, we can calculate the IRR using financial software or Excel's IRR function. The IRR for this project is approximately 12.67%.

Answer 2

The internal rate of return (IRR) for the investment in a new computer-based order entry system is calculated by considering the cost savings, depreciation, tax benefits, and the salvage value of the system, adjusted according to the tax rate of 24 percent.

Step-by-step explanation:

The question is asking to calculate the internal rate of return (IRR) for a proposed investment in a new computer-based order entry system. This system has a cost of $485,000, will provide annual savings of $140,000 before taxes, and enables a one-time reduction in working capital of $60,000. To calculate IRR, we need to take into account the depreciation of the system, which is straight-lined to zero over five years, the salvage value at the end of the system's life, and the tax implications on the cost savings. The provided tax rate is 24 percent.

The cash flows from the project would look something like this:

• 
  
• Year 0: Initial investment of $485,000 (negative cash flow), plus working capital reduction (positive cash flow)
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• Years 1-5: Annual operation cost savings before taxes (positive cash flow), net of taxes, and depreciation savings (positive cash flow)
• 
  
• Year 5: Salvage value of the system (positive cash flow)

To calculate the IRR, these cash flows are adjusted for taxes where applicable and equated to zero using the IRR formula. The IRR would be the discount rate that makes the net present value (NPV) of the cash flows equal to zero.