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Blue Moose Home Builders is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000. Blue Moose Home Builders has been basing capital budgeting decisions on a project's NPV; however, its new CFC wants to start using the IRR method for capital budgeting decisions. The CFO says that the IRR is a better metho because returns in percentage form are easier to understand and compare to required returns. Blue Moose Home Builders's WACC is 7%, and project Sigma has the same risk as the firm's average project. The project is expected to generate the following net cash flows:

Blue Moose Home Builders is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000. Blue Moose Home Builders has been basing capital budgeting decisions on a project's NPV; however, its new CFC wants to start using the IRR method for capital budgeting decisions. The CFO says that the IRR is a better metho because returns in percentage form are easier to understand and compare to required returns. Blue Moose Home Builders's WACC is 7%, and project Sigma has the same risk as the firm's average project. The project is expected to generate the following net cash flows:

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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**Blue Moose Home Builders Project Sigma Analysis** Blue Moose Home Builders is evaluating a proposed capital budgeting project named Project Sigma, which requires an initial investment of $800,000. Traditionally, Blue Moose Home Builders has used a project's NPV for making capital budgeting decisions. However, the company’s new CFO intends to switch to the IRR method, citing its ease of understanding and comparison with required returns, given that the IRR is expressed in percentage terms. The firm's WACC is 7%, and Project Sigma shares the same risk level as the company's average project. **Expected Net Cash Flows:** - **Year 1:** $375,000 - **Year 2:** $500,000 - **Year 3:** $425,000 - **Year 4:** $500,000 **IRR Calculation Options for Project Sigma:** - 36.58% - 32.51% - 34.54% - 40.64% **Decision Criteria:** - If the project is independent, the IRR method suggests that the firm should **accept** Project Sigma. For mutually exclusive projects where both have an IRR greater than the necessary WACC, the IRR method recommends that the firm should: - Select the project with the greatest IRR, provided both projects have the same risk as the firm's average project. The information provided guides Blue Moose Home Builders in making informed capital budgeting decisions using the IRR method.
Transcribed Image Text:**Blue Moose Home Builders Project Sigma Analysis** Blue Moose Home Builders is evaluating a proposed capital budgeting project named Project Sigma, which requires an initial investment of $800,000. Traditionally, Blue Moose Home Builders has used a project's NPV for making capital budgeting decisions. However, the company’s new CFO intends to switch to the IRR method, citing its ease of understanding and comparison with required returns, given that the IRR is expressed in percentage terms. The firm's WACC is 7%, and Project Sigma shares the same risk level as the company's average project. **Expected Net Cash Flows:** - **Year 1:** $375,000 - **Year 2:** $500,000 - **Year 3:** $425,000 - **Year 4:** $500,000 **IRR Calculation Options for Project Sigma:** - 36.58% - 32.51% - 34.54% - 40.64% **Decision Criteria:** - If the project is independent, the IRR method suggests that the firm should **accept** Project Sigma. For mutually exclusive projects where both have an IRR greater than the necessary WACC, the IRR method recommends that the firm should: - Select the project with the greatest IRR, provided both projects have the same risk as the firm's average project. The information provided guides Blue Moose Home Builders in making informed capital budgeting decisions using the IRR method.
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