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 Year 2 Year 3 Year 4 Cash Flow $275,000 $400,000 $450,000 $425,000 Which of the following is the correct calculation of project Sigma's IRR? O 30.88% o 26.85% o 29.54% O 32.22% 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? o The IRR would decrease. o The IRR would increase. o The IRR would not change