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 $1,500,000 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 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: Cash Flow Year Year 1 $275,000 Year 2 $400,000 Year 3 $500,000 Year 4 $400,000

Answer 1

IRR is the rate at which NPV = 0, and PV of Cash Inflow is equal to initial investment,

So,

1, 500, 000 = ΣC/(1+ IRR) t=1

Using Trial and Error Method,

IRR = 0.0186

IRR = 1.86%

As IRR < WACC(9%) project should not be taken.

With change in cost of capital IRR will not change as IRR depends only on the cash flows,

The IRR would not change.