Question

A stand-alone capital project has the following projected cash flows:

Year 0 1 2 3 Cash flow ($4,000) $1,500 $1,200 $2,395

If the firm's cost of capital is 14%, which of the following statements is true?

a.the IRR is greater than the cost of capital and the project should be undertaken
b.the project should be rejected because the IRR is 12%, which is less than the project's cost of capital
c.the IRR is less than 12% and the project should be undertaken
d.the NPV of the project is positive and the project should be undertaken

Answer 1

Cash Flows:
Year 0 = -$4,000
Year 1 = $1,500
Year 2 = $1,200
Year 3 = $2,395

Cost of Capital = 14%

NPV = -$4,000 + $1,500/1.14 + $1,200/1.14^2 + $2,395/1.14^3
NPV = -$144.29

Let IRR be i%

NPV = -$4,000 + $1,500/(1+i) + $1,200/(1+i)^2 + $2,395/(1+i)^3
0 = -$4,000 + $1,500/(1+i) + $1,200/(1+i)^2 + $2,395/(1+i)^3

Using financial calculator, i = 12%

Therefore, the project should be rejected because the IRR is 12%, which is less than the project's cost of capital.