Question

Three Waters Co. is evaluating a proposed capital budgeting project that will require an initial investment of $1,350,000. The project is expected to generate the following net cash flows:

Year Net Cash Flow

1 $300,000

2 $425,000

3 $400,000

4 $425,000

Three Waters Co. has been basing capital budgeting decisions on a project’s NPV; however, its new CFO wants to start using the internal rate of return (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. Three Waters Co.’s desired rate of return is 6%.

1. Which of the following is the IRR of the project?

4.80% 113.81% 6.00% 5.50% 6.50%

2. If this is an independent project, the IRR method states that the firm should _____?____ the project.

3. If the project’s desired rate of return increased, how would that affect the IRR?

The IRR will not change.

The IRR will increase.

The IRR will decrease.

Answer 1