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Aa Aa E. 2. Internal rate of return (IRR) The internal rate of return (IRR) refers to the compound annual rate of return that a
Aa Aa E. 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: Consider the following case: 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 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. Blue Pencil Publishing'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: Which of the following is the correct calculation of project Year Cash Flow Sigma's IRR? Year 1 $300,000 O 27.53% Year 2 $425,000 O 26.15%. Year 3 $400,000 O 24.78% O 22.02% Year 4 $425,000
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