please answer completely and correctly all questions thanks probGuid 010000003af
ID: 2782270 • Letter: P
Question
please answer completely and correctly all questions thanks
probGuid 010000003af26-00700008ckm 1510027916675 0AAA0STD C Q Search s. Internal rate of return (IRR) The internal rate of return (IRR) refers to the compound annual rate of return that a project generates based on its up-front cost and subsequent ashrows·Consider ttiscase Consider the fo lowing case: Grey Fox Aviation Company is evaluating a proposed capital budgeting project (project De'ta) that will require an nitial investment of $1,450,000. Grey Fox Aviation 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 recuired returns. Grey Fox Aviation Company's WACC is 10%, and project Delta has the same risk as the firm's average project. The project is expected to generate the following net cash flows: Which of the following is the correct calculation of project Delta's IRR? Year Cash Flow Year 1 $275,000 Year 2 $400,000 Year 3 $450,000 ear 4 $425,000 2.55% 2.81% 2.30% 9 2.17% 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? O The IRR would decrease. O The IRR would not change. O The IRR would increase.Explanation / Answer
NPV is calculated by discounting the cashflows
PV = C/(1+r)^n
C - Cashflow
r - Discount rate
n - years to the cashflow
IRR is the rate at whcih NPV = 0
NPV = -1450000 + 275000/(1+IRR)^1 + 400000/(1+IRR)^2 + 450000/(1+IRR)^3 + 425000/(1+IRR)^4 = 0
By trail and erro, IRR = 2.55%
Option A.
- Since this is an independent project, and IRR is less than WACC, firm should reject the project.
- Option B. IRR would not change, because IRR is independent of cost of capital.