Question

Project X has the following cash flows: C₀ = +2,000, C₁ = -1,300, and C₂ = -1,500. If the IRR of the project is 25 percent and if the cost of capital is 18 percent, you would

A. Accept the Project
B. Reject the Project

Answer 1

Given that Project X's IRR of 25 percent is higher than the cost of capital of 18 percent, the project should be accepted as it is expected to provide a return greater than the cost of the capital invested.

Step-by-step explanation:

Considering the cash flows and the Internal Rate of Return (IRR) of Project X, a decision can be made on whether to accept or reject the project based on its profitability in comparison to the cost of capital. The project cash flows are as follows: C₀ = +2,000, C₁ = -1,300, and C₂ = -1,500. The IRR is calculated to be 25 percent, which is a measure of the project's expected rate of return. When evaluating investments, if the IRR exceeds the cost of capital, which in this case is 18 percent, it indicates that the project is expected to generate returns greater than the opportunity cost of capital. Since the IRR of 25 percent is higher than the cost of capital (18 percent), you would accept the project, as it suggests that the project will add value to the firm. To determine whether to accept or reject the project, we can compare the internal rate of return (IRR) with the cost of capital. If the IRR is greater than the cost of capital, it indicates a positive return on investment, and the project should be accepted. In this case, the IRR of the project is 25 percent, which is higher than the cost of capital of 18 percent. Therefore, the project should be accepted.

Answer 2

Despite the student's initial indication to reject Project X, the correct action would be to accept it since its IRR of 25% is higher than the cost of capital of 18%, implying a profitable investment.

Step-by-step explanation:

Project X has cash flows of C₀ = +$2,000, C₁ = -$1,300, and C₂ = -$1,500. Given that the internal rate of return (IRR) is 25% and that the cost of capital is 18%, the decision whether to accept or reject the project would depend on comparing the IRR with the cost of capital.

Since the IRR of 25% is higher than the cost of capital of 18%, this suggests that the project's return exceeds the opportunity cost of the capital, implying that the project is expected to generate value beyond its cost. Thus, under these circumstances, it would be financially beneficial to accept the project rather than reject it.

However, the initial question suggests to reject the project despite the IRR exceeding the cost of capital. This may be due to a typo or misunderstanding because, in typical financial analysis, a project with an IRR greater than the cost of capital would be accepted.