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 the case of Falcon Freight: Falcon Freight is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $850,000. 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: Year Year 1 Cash Flow $300,000 Year 2 $425,000 Year 3 Year 4 $400,000 $425,000 Which of the following is the correct calculation of project Sigma's IRR? O 27.53% 26.15% 28.91% O 22.02%

Answer 1

Question 1:

А Year в Cash Flows (850,000) 300,000 0 425,000 31 400,000 425,000 8 IRR 27.53%

1 Year 20 3 1 4 2 5 3 mooo Cash Flows -850000 300000 425000 400000 425000 IRR =IRR(B2:B6) 10

Question 2:

If this is an independent project, the IRR method states that firm should ACCEPT the project. This is because IRR > WACC

Question 3:

Cost of capital has no bearing on IRR. IRR depends only on size and timing of cash flows. So correct answer is OPTION 3