Question

2. Internal rate of return (IRR) 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: Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,450,000. Blue Llama Mining 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. Blue Llama Mining Company's WACC is 10%, and project Delta has the same risk as the firm's average project. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 Year 2 Year 3 Year 4 $325,000 $450,000 $425,000 $450,000 Which of the following is the correct calculation of project Delta's IRR? O 5.91% O 5.14% 5.40% 4.11% 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. O The IRR would decrease. The IRR would increase.

Answer 1

Question 1:

0 ДА В 1 Year Cash Flow (1,450,000) 3 1 325,000 4 2 450,000 53 425,000 450,000 a mano 8 IRR 5.14%

A 1 Year 20 3 1 42 Cash Flow -1450000 325000 450000 425000 64 450000 =IRR(B2:B6) 8 IRR 9

Question 2:

If this is an independent project, the IRR method states that the firm should REJECT the project (given WACC > IRR).

Question 3:

Answer is Option 1

IRR is independent of the cost of capital. It is only dependent on the size and timing of cash flows.