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 Blue Pencil Publishing: Blue Pencil Publishing is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $850,000. Blue Pencil Publishing has been basing capital budgeting decisions on a projects 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. Blue Pencil Publishings WACC is 8%, and project Sigma has the same risk as the firms average project. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $275,000 Year 2 $400,000 Year 3 $450,000 Year 4 $425,000 Which of the following is the correct calculation of project Sigmas IRR?