With a purchase price of $350,000, a small warehouse provides for an initial before-tax cash flow of $30,000, which grows by 6 percent per year. If the before-tax equity reversion after four years equals $90,000, and an initial equity investment of $175,000 is required, what is the IRR on the project? If the required going-in levered rate of return on the project is 10 percent, should the warehouse be purchased?
Solution:
|
Year |
Purchase Price | Before-Tax Cash Flow | Before-Tax Equity Reversion | Total Cash Flow | Present Value at 10% |
| 0 | ($175,000) | ($175,000) | ($175,000) | ||
| 1 | 30,000 | 30,000 | 27,272 | ||
| 2 | 31,800 | 31,800 | 26,281 | ||
| 3 | 33,708 | 33,708 | 25,325 | ||
| 4 | 35,730 | 90,000 | $125,730 | $85,875 |
The IRR is 7.84 percent. Based on a going-in levered rate of return on the project of 10 percent, the NPV equals ($10,246) and the project should not be undertaken.
