Question

**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 this case of Blue Llama Mining Company:

Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,600,000.

Blue Llama Mining Company 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 percentages and returns are easier to understand and to compare to required returns. Blue Llama Mining Company’s WACC is 8%, and project Delta 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 | $375,000 |

Year 2 | $500,000 |

Year 3 | $450,000 |

Year 4 | $475,000 |

Which of the following is the correct calculation of project Delta’s IRR?

4.74%

5.69%

4.03%

4.27%

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?

The IRR would increase.

The IRR would decrease.

The IRR would not change.

Answer #1

Answer a.

Cash Flows:

Year 0 = -$1,600,000

Year 1 = $375,000

Year 2 = $500,000

Year 3 = $450,000

Year 4 = $475,000

Let IRR be i%

NPV = -$1,600,000 + $375,000/(1+i) + $500,000/(1+i)^2 +
$450,000/(1+i)^3 + $475,000/(1+i)^4

0 = -$1,600,000 + $375,000/(1+i) + $500,000/(1+i)^2 +
$450,000/(1+i)^3 + $475,000/(1+i)^4

Using financial calculator, i = 4.74%

Internal Rate of Return = 4.74%

Answer b.

If this is an independent project, the IRR method states that the firm should not accept Project Delta.

Answer c.

If the project’s cost of capital were to increase, the IRR would not change.

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 this case:
Blue Llama Mining Company is evaluating a proposed capital
budgeting project (project Delta) that will require an initial
investment of $1,600,000.
Blue Llama Mining Company 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....

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budgeting project (project Delta) that will require an initial
investment of $1,500,000.
Blue Llama Mining Company 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 percentages and returns are
easier to understand and to compare to required returns. Blue Llama
Mining Company’s WACC is...

Blue Llama Mining Company is evaluating a proposed capital
budgeting project (project Delta) that will require an initial
investment of $1,600,000. Blue Llama Mining Company 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
percentages and returns are easier to understand and to compare to
required returns. Blue Llama Mining Company’s WACC is...

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methods of investment analysis are interrelated and are sometimes
used together to make capital budgeting decisions.
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Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of
its planning and financial data when both its main and its backup
servers crashed. The company’s CFO remembers that the internal rate
of return (IRR) of Project Delta is 11.3%, but he can’t recall how...

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methods of investment analysis are interrelated and are sometimes
used together to make capital budgeting decisions.
Consider the case of Blue Hamster Manufacturing Inc.:
Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of
its planning and financial data when both its main and its backup
servers crashed. The company’s CFO remembers that the internal rate
of return (IRR) of Project Delta is 11.3%, but he can’t recall how...

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methods of investment analysis are interrelated and are sometimes
used together to make capital budgeting decisions.
Consider the case of Blue Hamster Manufacturing Inc.:
Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of
its planning and financial data when both its main and its backup
servers crashed. The company’s CFO remembers that the internal rate
of return (IRR) of Project Delta is 11.3%, but he can’t recall how...

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methods of investment analysis are interrelated and are sometimes
used together to make capital budgeting decisions.
Consider the case of Blue Hamster Manufacturing Inc.:
Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of
its planning and financial data when both its main and its backup
servers crashed. The company’s CFO remembers that the internal rate
of return (IRR) of Project Delta is 11.3%, but he can’t recall how...

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