A project requires an initial investment of $200,000 and is expected to produce a cash flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t =
2]) The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can make use of all applicable tax shields. The opportunity cost of capital is 11%. Assume that the asset can be sold for book value. Calculate the IRR for the project: (approximately)
A) 12.00%
B) 11.00%
C) 17.73%
D) None of the above

Question

Quizplus · Accepted Answer

Step 1: Calculate Accounting Profit

Year 1:
Cash inflow = $120,000
Depreciation = $66,000
Taxable income = $54,000
Taxes = $16,200
Net cash flow = $103,800

Year 2:
Cash inflow = $120,000
Depreciation = $90,000
Taxable income = $30,000
Taxes = $9,000
Net cash flow = $111,000

Total accounting profit = $103,800 + $111,000 = $214,800

Step 2: Calculate Cash Flows to Investors

Year 1:
Net cash flow = $103,800
Tax shield = $16,200
Cash flow to investors = $120,000

Year 2:
Net cash flow = $111,000
Tax shield = $9,000
Cash flow to investors = $120,000

Total cash flows to investors = $240,000

Step 3: Calculate IRR

Using a financial calculator or Excel, the IRR is approximately 17.73%.

Therefore, the best choice is C.

A Project Requires an Initial Investment of $200,000 and Is