Question

which one is the right answer? Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,450,000. 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 9%, 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 $275,000 Year 2 $400,000 Year 3 $450,000 Year 4 $425,000 Which of the following is the correct calculation of project Delta's IRR? A. 2.81% B. 2.55% C. 2.42% D. 2.68%

Answer 1

To calculate the IRR of project Delta, we need to find the discount rate that makes the net present value (NPV) of the cash flows equal to zero. Using the cash flows provided and the company's WACC of 9%, the correct calculation of project Delta's IRR is 2.68%.

Step-by-step explanation:

To calculate the IRR of project Delta, we need to find the discount rate that makes the net present value (NPV) of the cash flows equal to zero. We can calculate the NPV by discounting each cash flow using the company's weighted average cost of capital (WACC). The IRR is the discount rate that gives us an NPV of zero.

Using the cash flows provided, the NPV at the WACC of 9% is:

NPV = -1,450,000 + (275,000 / 1.09) + (400,000 / 1.09^2) + (450,000 / 1.09^3) + (425,000 / 1.09^4)

Simplifying the equation gives us:

NPV = -197,321.35

We can use trial and error or financial software to find the IRR that makes the NPV equal to zero. Using trial and error, we find that an IRR of approximately 2.68% gives us an NPV close to zero. Therefore, the correct calculation of project Delta's IRR is option D, 2.68%.