Question
2. Your firm is contemplating the purchase of a new $560,000 computer-based order entry system. The system will be depreciated straight-line to zero over its
2. Your firm is contemplating the purchase of a new $560,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $56,000 at the end of that time. You will save $280,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $71,000 (this is a one-time reduction). If the tax rate is 34 percent, what is the IRR for this project?(Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Refer to notebook notes for better solve.
Explanation:
First, we will calculate the annual depreciation of the new equipment. It will be:
Annual depreciation charge = $560,000 / 5
Annual depreciation charge = $112,000
The aftertax salvage value of the equipment is:
Aftertax salvage value = $56,000(1 .34)
Aftertax salvage value = $36,960
Using the tax shield approach, the OCF is:
OCF = $280,000(1 .34) + .34($112,000)
OCF = $222,880
Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project. The IRR of the project is:
NPV = 0 = $560,000 + 71,000 + $222,880(PVIFAIRR%,4) + [($222,880 + 36,960 71,000) / (1 + IRR)5]
IRR = 34.79%
QUESTION: CAN SOMEONE EXPLAIN THE BOLDED PORTION USING A CALCULATOR, DON'T UNDERSTAND HOW TO COMPUTE THE "(1+IRR)" OR THE "(PVIFAIRR&4)".
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