Blue Moose Home Builders s evaluating a proposed capital budgeting project (proj

Question

Blue Moose Home Builders s evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,500,000. Blue Moose Home Builders 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 Moose Home Builders? WACC is 8%, 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? 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 not change. The IRR would decrease. The IRR would increase.

Explanation / Answer

Ans 1

IRR=3.74%

Note -IRR is the rate at which NPV of cash flows under the project becomes 0

Ans 2

If this is an independend project IRR states that firm should not accept the project since the IRR is less than the required rate of return (WACC) of 8%

Ans 3

IRR would not change.

Workings and details

Expected Cashflows Type Amount PVDF @ 3.74% NPV Y0 Initial Investment -15,00,000.00 1 -15,00,000.00 Y1 Cash inflow       3,25,000.00 0.963993643       3,13,297.93 Y2 Cash inflow       4,50,000.00 0.929283744       4,18,177.68 Y3 Cash inflow       4,00,000.00 0.895823623       3,58,329.45 Y4 Cash inflow       4,75,000.00 0.863568278       4,10,194.93                    -0.00 IRR 3.74%

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