Hydroponics is considering adding another greenhouse that would cost $95,000 and generate $20,000 in annual net cash flows over its 8-year expected life. The greenhouse would be depreciated on a straight-line basis to zero, and the salvage value is also expected to be zero. If the firm has a marginal tax rate of 40%, what is this project's internal rate of return?
A) between 20% and 24%
B) between 13% and 14%
C) between 28% and 32%
D) between 7% and 8%

Question

Quizplus · Accepted Answer

To find the internal rate of return (IRR) for this project, we first calculate the net annual cash flow after taxes and depreciation. The depreciation expense is $95,000 / 8 = $11,875 per year. The taxable income reduction due to depreciation is $20,000 - $11,875 = $8,125. Taxes saved due to depreciation are $8,125 * 40% = $3,250. So, the net annual cash flow is $20,000 + $3,250 = $23,250. Given the initial investment of $95,000 and the net annual cash flow, the IRR falls into the range of 13% to 14%, considering the project's life and the nature of the cash flows.

Hydroponics Is Considering Adding Another Greenhouse That Would Cost $95,000