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436 Corporate Finance BRILLIANT’S

Illustration 5.1.11
A Ltd. proposes to buy a machine for ` 1,00,000 which has a working life of 4 years after
which it can be sold for ` 20,000. It will increase the sales by ` 2,00,000 but cost of sales and other
operating expenses will also increase by ` 1,60,000. If corporate tax rate is 50%, compute internal
rate of return.
A {b{‘Q>oS>$< 1,00,000 H$s EH$ ‘erZ IarXZo H$m àñVmd XoVr h¡ {OgH$m H$m¶© OrdZ 4 df© h¡, {OgHo$ níMmV²
Bgo < 20,000 ‘| ~oMm Om gH$Vm h¡& ¶h {dH«$¶ H$mo < 2,00,000 VH$ ~‹T>m¶oJm {H$ÝVw {dH«$¶ VWm Aݶ Am°naoqQ>J 춶
H$s bmJV < 1,60,000 VH$ ~‹T> Om¶oJr& ¶{X H$m°nm}aoQ> Q>¡³g aoQ> 50% h¡ Vmo [aQ>Z© H$s B§Q>Z©b aoQ> H$s JUZm H$s{OE&

Solution:
Calculation of Cash Inflows
Year Net Depre– Profits Tax @ Profits Cash
Revenue ciation Before Tax 50% After Tax Inflows
(`) (`) (`) (`) (`) (`)
1 2 NPP 4 5 6 7 (3 + 6)
3
1 40,000 20,000 20,000 10,000 10,000 30,000
2 40,000 20,000 20,000 10,000 10,000 30,000
3 40,000 20,000 20,000 10,000 10,000 30,000
4 40,000 20,000 20,000 10,000 10,000 30,000

Discounting the Cash Inflows at 10%, 12% and 15%.

Year Cash PV Factor Total PV
Inflows 10% 12% 15% 10% 12% 15%
(`) (`) (`) (`) (`) (`) (`)

1–4 30,000 3.170 3.037 2.855 95,100 91,110 85,650
4 20,000 0.683 0.636 0.572 13,660 12,720 11,440
1,08,760 1,03,830 97,090
Less: Outflows 1,00,000 1,00,000 1,00,000
NPV 8,760 3,830 (–) 2,910

Thus, IRR is between 12% and 15%, i.e. more than 12% but less than 15%. Difference between
PV at 12% and 15% is ` 6,740, i.e. 1,03,830 – 97,090 and the negative NPV of ` 2,910 has to be
covered by this amount to arrive at IRR.
Formula:
NPV of HigherRate
IRR = Higher Rate –  Difference in rate
Difference in Cash Inflows
OR