Question

. 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:

Year	Cash Flow
Year 1	$300,000
Year 2	$425,000
Year 3	$475,000
Year 4	$450,000

Which of the following is the correct calculation of project Delta’s IRR?

2.95%

4.43%

4.24%

3.69%

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 decrease.

The IRR would not change.

The IRR would increase.

Answer 1

2 ДА В 1 Year Cash flows 0 $ (1,500,000) 3 1 $ 300,000 2 $ 425,000 5 3 $ 475,000 4 $ 450,000 4 6 8 IRR 3.69% =IRR(B2:37) 10 Reject project 11 12 "The IRR would not change"

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