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
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 Purple Whale Foodstuffs Inc.:
Purple Whale Foodstuffs Inc. is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $900,000.
Purple Whale Foodstuffs Inc. 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. Purple Whale Foodstuffs Inc.s WACC is 9%, 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 | $300,000 |
Year 2 | $425,000 |
Year 3 | $475,000 |
Year 4 | $450,000 |
Which of the following is the correct calculation of project Sigmas IRR?
28.63%
27.27%
24.54%
32.72%
If this is an independent project, the IRR method states that the firm should _____(accept/reject) project Sigma .
If the projects cost of capital were to increase, how would that affect the IRR?
The IRR would increase.
The IRR would decrease.
The IRR would not change.
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