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 $850,000.

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	$375,000
Year 2	$500,000
Year 3	$450,000
Year 4	$475,000

i. Which of the following is the correct calculation of project Sigmas IRR?

a. 35.15%

b. 37.00%

c. 29.60%

d. 40.70%

ii. If this is an independent project, the IRR method states that the firm should ___.

a. accept project Sigma

b. reject project Sigma

iii. If the projects cost of capital were to increase, how would that affect the IRR?

a. The IRR would not change.

b. The IRR would increase.

c. The IRR would decrease.