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 $$800,000.$

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

Cash Flow

Year $1$ $$350,000$

Year $2$ $$475,000$

Year $3$ $$425,000$

Year $4$ $$500,000$

Which of the following is the correct calculation of project Sigma$$s IRR?

$42\mathrm{.}02\%$

$38\mathrm{.}20\%$

$36\mathrm{.}29\%$

$40\mathrm{.}11\%$

If this is an independent project, the IRR method states that the firm should $\_\_\_\_\_($reject or accept$).$

If the project$$s 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.