firm with a cost of capital of 13 percent is evaluating three capital projects.

Question

firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows:

Project Internal Rate of Return
1 12%
2 15
3 14
The firm should __________.

Explanation / Answer

IRR is basically the rate at which for any given project, the NPV = 0. That rate is then compared to the discount rate. If IRR > than the discount rate we would accept the project because we would be creating a project that returns more than it costs, and thus creates value. Since our cost of capital is 13%, we would accept the project with the highest difference between IRR and the cost of capital, which would be project 2. Hope this helps!

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