Question

The internal rate of return (IRR) refers to the compound annual rate of return that a project generates based on its up-front cost and subsequent cash flows. Consider this case: Consider the following case: Fuzzy Badger Transport Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,500,000. Fuzzy Badger Transport Company has been basing capital budgeting decisions on a project's NPV; however, its new CFO wants to start using the IRR method for capital budgeting decisions. The CFO says that the IRR is a better method because percentages and returns are easier to understand and to compare to required returns. Fuzzy Badger Transport Company's WACC is 9%, and project Delta has the same risk as the firm's average project. The project is expected to generate the following net cash flows: Which of the following is the correct calculation of project Delta's IRR? Year Year 1 Year 2 Year 3 Year 4 Cash Flow $350,000 $475,000 $400,000 $475,000 05.01% O 5.76% 5.26% 4.26% If this is an independent project, the IRR method states that the firm should If the project's cost of capital were to increase, how would that affect the IRR? O The IRR would not change. The IRR would increase. The IRR would decrease.

Answer 1

Calculate the IRR as follows:

А B ایراس 158 Year Cash flows 159 -1500000 160 350000 161 475000 162 3 400000 4 475000 164 IRR 5.01% 165 Independent project Reject. 166 Cost of capital is changed, 167 Porject IRR will not change. 163

Formulas:

B A 158 Year Cash flows 159 0 - 1500000 160 1 350000 161 2 475000 162 3 400000 1634 475000 164 IRR =IRR(B159:B163) 165 Independent project Reject. Cost of capital is changed, 167 Porject IRR will not change. 166