Principal payment should not be changed by inflation rate

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Reference no: EM132055998

"A firm is considering purchasing a computer system.

-Cost of system is $186,000. The firm will pay for the computer system in year 0.

-Project life: 6 years

-Salvage value in year 0 (constant) dollars: $17,000

-Depreciation method: five-years MACRS

-Marginal income-tax rate = 35% (remains constant over time)

-Annual revenue = $134,000 (year-0 constant dollars)

-Annual expenses (not including depreciation) = $87,000 (year-0 constant dollars)

-The general inflation rate is 4.5% during the project period (which will affect all revenues, expenses, and the salvage value but not depreciation).

-The firm borrows the entire $186,000 at 14% interest to be repaid in 2 annual payments. The debt interest paid and the principal payment SHOULD NOT be changed by the inflation rate. Lending agencies set the interest rate of borrowing to account for the inflation rate.

Calculate the effects of borrowing and include the debt interest paid and the principal repayment into the income statement and cash flow statement. Determine the INFLATION-FREE IRR' of the computer system. Enter your answer as a percentage between 0 and 100."

Reference no: EM132055998

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