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Which of the following is the correct calculation of project Delta's IRR?

Which of the following is the correct calculation of project Delta's IRR?

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
Section: Chapter Questions
Problem 1PS
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Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,600,000. 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 7%, 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 $375,000 Year 2 $500,000 Year 3 $450,000 Year 4 $475,000 Which of the following is the correct calculation of project Delta's IRR? 4.98% 4.27% 5.45% 4.74%
Transcribed Image Text:Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,600,000. 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 7%, 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 $375,000 Year 2 $500,000 Year 3 $450,000 Year 4 $475,000 Which of the following is the correct calculation of project Delta's IRR? 4.98% 4.27% 5.45% 4.74%
If this is an independent project, the IRR method states that the firm should If the project's cost of capital were to increase, how would that affect the IRR? The IRR would increase. The IRR would not change. The IRR would decrease.
Transcribed Image Text:If this is an independent project, the IRR method states that the firm should If the project's cost of capital were to increase, how would that affect the IRR? The IRR would increase. The IRR would not change. The IRR would decrease.
Expert Solution
Step 1

Internal Rate of Return (IRR):

It is the rate of return at which a project's net present value becomes zero. Hence, the internal rate of return makes the present value of cash flows equal to the initial investment of the project. 

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