Question

Purple Whale is evaluating a proposed capital budgeting project (project sigma) that will require an initial investment of $900,000. Purple Whale 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 returns in percentage form are easier to understand and compare to required returns. Purple Whale's WACC is 9% and project sigma has the same risk as the firm's average project.
The project is expected to generate the following net cash flows:
Year 1 325,000
Year 2 450,000
Year 3 425,000
Year 4 450,000
Which of the following is the correct calculation of project sigma's IRR?
a. 22.34%,
b. 27.93%,
c. 23.74%,
d. 25.14%
If this is an independent project, the IRR method states that the firm should (accept or reject)? project sigma??
If mutually exclusive projects are proposed that both have an IRR greater than the necessary WACC, the IRR method states that the firm should accept which of the following:
A. the project with the greater future cash inflows, assuming that both projects have the same risk as the firm's average project.
B. the project with the greatest IRR, assuming that both projects have the same risk as the firm's average project.
C. The project that requires the lowest initial investment, assuming that both projects have the same risk as the firm's average project.

Answer 1

b

accept

b

Step-by-step explanation:

Internal rate of return is the discount rate that equates the after-tax cash flows from an investment to the amount invested

IRR can be calculated with a financial calculator

Cash flow in year 0 = $-900,000

Cash flow in year 1 = 325,000

Cash flow in year 2 = 450,000

Cash flow in year 3 = 425,000

Cash flow in year 4 = 450,000

IRR = 27.93%

The IRR is greater than the WACC of the project. This means that the project is profitable and the project should be accepted

The higher the IRR, the more profitable the project is. the decision rule is to select the project with the highest IRR

To determine IRR using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the IRR button and then press the compute button.