Callendula Company is considering the purchase of a new machine for $80,000. The machine would generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five 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 need to find the discount rate that makes the net present value (NPV) of the cash flows from the machine equal to zero. We can use the following formula to calculate the NPV:

NPV = -Initial cost + (Cash flows / (1+discount rate)^year) - (Tax rate * Depreciation / (1+discount rate)^year)

where:
- Initial cost = $80,000
- Cash flows = $28,778
- discount rate = we need to find it
- year = year 1 to year 5
- Tax rate = 40%
- Depreciation = (Initial cost - Salvage value) / Useful life = ($80,000 - $0) / 5 = $16,000

Setting the NPV formula to zero, we can solve for the discount rate using Excel's IRR function or trial and error method. The IRR for this investment is approximately 14.7%, which is between 14% and 16%. Therefore, the best choice is B.

Callendula Company Is Considering the Purchase of a New Machine