Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

Assume that the after-tax hurdle rate for accepting new capital investment projects by the company is 4%, after-tax. (Note: To answer this question, students will have to be provided with the Tables provided in Appendix C, Chapter 12. Alternatively, the instructor can provide students with the following PV $1 factors for 4%: for year 1 = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.) The estimated internal rate of return (IRR) on this investment is:
A) Less than 4%.
B) 4%.
C) Slightly above 4%.
D) Greater than 6%.
E) Undeterminable with only the given information.

Question

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

Assume that the after-tax hurdle rate for accepting new capital investment projects by the company is 4%, after-tax. (Note: To answer this question, students will have to be provided with the Tables provided in Appendix C, Chapter 12. Alternatively, the instructor can provide students with the following PV $1 factors for 4%: for year 1 = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.) The estimated internal rate of return (IRR) on this investment is:
A) Less than 4%.
B) 4%.
C) Slightly above 4%.
D) Greater than 6%.
E) Undeterminable with only the given information.

Quizplus · Accepted Answer

To determine the IRR, we need to calculate the present value (PV) of the after-tax cash inflows and compare it to the initial investment. Using the provided PV factors for a 4% discount rate, the calculation is as follows: ($18,000 * 0.962) + ($15,000 * 0.925) + ($9,000 * 0.889) + ($6,000 * 0.855) + ($3,000 * 0.822) = $17,316 + $13,875 + $8,001 + $5,130 + $2,466 = $46,788. Since the PV of the cash inflows ($46,788) is greater than the initial investment ($45,000), but without a detailed calculation for rates higher than 4%, we can infer that the IRR is slightly above 4%.

Brandon Company Is Contemplating the Purchase of a New Piece