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 Lama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,500,000 Blue Liana Mining Company has been basing capital budgeting decisions on a project's NPV; however, its new CFO wants to start using the method for a budgeting decisions. The CFO says that the IRR is a better method because percentages and returns are casier to understand and to compare to required returns. Lama Mining Company's WACC is 8%, and project Delta has the same risk as the firm's average project. The proj ected to get the chos Year Cash Flow ei 275.000 1400.000 Year Year Year 500.000 $400,000

Answer 1

1). To find the IRR, we need to put the following values in the financial calculator:

CF0 = -1,500,000; C01 = 275,000; F01 = 1; C02 = 400,000; F02 = 1; C03 = 500,000; F03 = 1; C04 = 500,000; F04 = 1;

Press IRR, then CPT, which gives us 1.86%

So, IRR = 1.86%

2). According to IRR method, the firm should reject the project, as the IRR is less than WACC.

3). Discount rate will not affect the IRR.