Question

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $158,900 a year. The project will require new equipment costing $571,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $163,000 at the end of the project. The project requires an initial investment of $37,500 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

Answer 1

Initial Investment = $571,000
Useful Life = 5 years
Initial Investment in NWC = $37,500
Salvage Value = $163,000
Annual OCF = $158,900

After-tax Salvage Value = $163,000 * (1 - 0.35)
After-tax Salvage Value = $105,950

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$571,000 - $37,500
Net Cash Flows = -$608,500

Year 1 to Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $158,900

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $158,900 + $37,500 + $105,950
Net Cash Flows = $302,350

Let IRR be i%

NPV = -$608,500 + $158,900/(1+i) + $158,900/(1+i)^2 + $158,900/(1+i)^3 + $158,900/(1+i)^4 + $302,350/(1+i)^5
0 = -$608,500 + $158,900/(1+i) + $158,900/(1+i)^2 + $158,900/(1+i)^3 + $158,900/(1+i)^4 + $302,350/(1+i)^5

Using financial calculator, i = 14.71%

Internal Rate of Return = 14.71%

So, IRR of the project is 14.71%