Question

2. Internal rate of return (IRR) Aa Aa 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 the case of Falcon Freight: Consider the following case: Falcon Freight is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000. Falcon Freight 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. Falcon Freight's WACC is 8%, and project Sigma 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 Sigma's IRR? Year Cash Flow Year 1 $350,000 Year 2 $475,000 Year 3 $425,000 Year 4 $500,000 О 32.47% O 36.2996 O 38.20% О 34.38% If this is an independent project, the IRR method states that the firm should

Answer 1

800,000 = 350,000/(1+IRR) + 475000/(1+IRR)² + 425000/(1+IRR)​​​³ + 500,000/(1+IRR)⁴

	A	B	C	D	E
1	$(800,000.00)	$ 350,000.00	$ 475,000.00	$ 425,000.00	$ 500,000.00
IRR	38.20%	Excel formula=IRR(A1:E1)

a) IRR = 38.20%

b) IRR would not change

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