Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000.
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 returns in percentage form are easier to understand and compare to required returns. Blue Llama Mining Company’s WACC is 7%, and project Sigma 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 | $275,000 |
Year 2 | $400,000 |
Year 3 | $500,000 |
Year 4 | $400,000 |
Which of the following is the correct calculation of project Sigma’s IRR?
29.54%
26.43%
37.31%
31.09%
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?
The IRR would increase.
The IRR would not change.
The IRR would decrease.
Let irr be x%
At irr,present value of inflows=present value of outflows.
800,000=275,000/1.0x+400,000/1.0x^2+500,000/1.0x^3+400,000/1.0x^4
Hence x=irr=31.09%(Approx).
Hence since irr is greater than WACC;project must be accepted
IRR is independent of change in cost of capital.Hence IRR would be unaffected by change in cost of capital.
Hence the correct option is:
The IRR would not change.
Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Sigma) that will require...
Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000. 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 returns in percentage form are easier to understand and compare to required returns. Blue Llama Mining Company's WACC is...
Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $900,000. 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 returns in percentage form are easier to understand and compare to required returns. Blue Llama Mining Company’s WACC is...
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