Question

should accept/reject

Blue Ulama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an IMUS Investment Or $1,40UUUU The 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: Year Year 1 Year 2 Year 3 Cash Flow $300,000 $425,000 $400,000 Year 4 $425,000 which of the following is the correct calculation of project Delta's IR 3.21% 4.81% 4.019 4.61% s

Answer 1

1. IRR can be found using IRR function in EXCEL

=IRR(values)

=IRR(Year0 to Year4 cashflows)

IRR=4.01% (option c is correct)

Year Cashflow 0 -1400000 1 300000 2 425000 3 400000 4 425000 IRR 14.01%

IRR is the internal rate of return where NPV=0, in a nutshell this the breakeven rate where your present value of future cashflows and intial cashflow are equal.

2.In this case, IRR<WACC (4.01%<9.0%). So project is not vaible and hence the firm should reject the project Delta

3. If cost of capital increases, it does not affect IRR. As I already told, IRR is calculated based on the future cashflows and present cost outlay. But whether to accept or reject the project, it depends on the cost of capital.

If IRR>cost of capital (accept the project)

If IRR<cost of capital (reject the project)