Ursula Company is considering the purchase of a new machine for $160,000. The machine would generate an annual cash flow before depreciation and taxes of $62,588 for four years. At the end of four years, the machine would have no salvage value. The company's cost of capital is 12 percent. The company uses straight-line depreciation with no mid-year convention and has a 40 percent tax rate. What is the internal rate of return for the machine rounded to the nearest percent?

Question

Quizplus · Accepted Answer

To calculate the internal rate of return (IRR), we first need to determine the net cash flows from the investment. The machine costs $160,000 and generates annual cash flows before depreciation and taxes of $62,588. With straight-line depreciation, the annual depreciation expense is $160,000 / 4 = $40,000. The taxable income each year is $62,588 - $40,000 = $22,588. Taxes on this income at a 40% rate are $22,588 * 40% = $9,035.2. Thus, the net annual cash flow after taxes is $62,588 - $9,035.2 = $53,552.8. The IRR must be calculated using these net cash flows and the initial investment, which typically requires financial calculator or software. Given the options and the provided cash flows, the IRR falls between 12 and 14%, considering the cost of capital is 12% and the investment seems to be profitable but not excessively so.

Ursula Company Is Considering the Purchase of a New Machine