The Basics of Capital Budgeting: IRR IRR A project's internal rate of return lRR is the discount at for calculating the IRR is: : that forces the PV of its inno s to equal its cost. The IRR is an estimate of the project's rate of return, and it is comparable to the YTM on a bond. The equation 1IRR 1 IRR 1IRR CF IRR) CFt is the expected cash flow in Period t and cash outflows are treated as negative cash flows. There must be a change in cash flow signs to callate the IRR. The IRR equation is simply the NPV cquation solved for the particular discount rate that causes NPV to equal zero The IRR calculation assumes that cash flows are reinvested at the IRR risk-adjusted cost of capital, then the project should be method. Two basic conditions can lead to conflicts between NPV and IRR: tim other when mutually exclusive projects are considered, then the NPV method should be used to evaluate projects. f the IRR isgreoter than the project's risk-adjusted cost of capital, then the project should be accepted; however, if the IRR is less than the projects Because of the IRR reinvestment rate assumption, when the pro Because ofthe should be rejected. exclusive projects are evaluated the IRR approach can lead to conflicting results from the NPV Two basic conditions can lead to i differences earlier cash flows n one p ec vs. ater cash flows n the o her project and project size the cost of one project is larger than the Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 9%. 320 270 Project A 1,000 650 Project B 1,000 2 390 840 250 255 420 What is Project A's IRR? Do not round intermediate calculations. Round your answer to two decimal places. What is Project B's IRR? Do not round intermediate calculations. Round your answer to two decimal places. If the projects were independent, which project(s) would be accepted according to the IRR method? Select If the projects were mutually cxclusive, which projoct(s) would be accepted according to the IRR method? Select- Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive? Selact The reason isSeloct Reinvestment at the -Select is the superior assumption, so when mutually exclusive projects are evaluated the -Seloctapproach should be used for the capital budgeting decision