Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

What is the approximate internal rate of return (IRR) of the investment? (NOTE: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.) Assume that annual after-tax cash flows occur at year-end.
A) Less than 12%.
B) Somewhere between 12% and 14%.
C) Somewhere between 15% and 20%.
D) Somewhere between 20% and 25%.
E) Over 25%.

Question

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

What is the approximate internal rate of return (IRR) of the investment? (NOTE: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.) Assume that annual after-tax cash flows occur at year-end.

What is the approximate internal rate of return (IRR) of the investment? (NOTE: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.) Assume that annual after-tax cash flows occur at year-end.
A) Less than 12%.
B) Somewhere between 12% and 14%.
C) Somewhere between 15% and 20%.
D) Somewhere between 20% and 25%.
E) Over 25%.

Quizplus · Accepted Answer

To calculate the IRR, we need to find the discount rate that makes the present value of the cash inflows equal to the initial investment. Using a financial calculator or the table provided in Appendix C, we can find that the present value of the cash inflows is approximately $741,485. To find the discount rate that makes this present value equal to the initial investment of $300,000, we can use trial and error or interpolation. The approximate IRR is around 17.1%, which falls between 15% and 20%, making choice C the correct answer.

Pique Corporation Wants to Purchase a New Machine for $300,000