Final answer:
The IRR of a project is determined by finding the discount rate that makes the NPV of all cash flows equal to zero. If the IRR exceeds the required rate of return, which includes the opportunity cost and a risk premium, it is advisable to invest in the project. In this case, if the IRR is higher than 15%, the investment is deemed worthy.
Step-by-step explanation:
Calculating the Internal Rate of Return (IRR)
To calculate the IRR of a project, a financial analyst will set the net present value (NPV) of all cash flows from the investment equal to zero and solve for the discount rate, which is the IRR. The IRR decision rule posits that if the IRR is greater than the project's required rate of return, the investment should be made. In this scenario, the required rate of return is set at 15%, including the risk premium due to the project's risk level.
Firms acquire financial capital to fund projects through various means such as early-stage investors, reinvested profits, loans, or issuing stock. When choosing between these sources, they must consider the cost associated with each option.
The IRR is particularly useful for comparing the profitability of investments or projects. It represents the point at which the project breaks even in terms of NPV. If the IRR is higher than the 15% hurdle rate in this example, it suggests that the project is expected to generate enough returns to compensate for the opportunity cost of capital and the associated risks, and thus, investing in it is advisable.