Consider the following case: Blue Moose Home Builders is evaluating a proposed c

Question

Consider the following case: Blue Moose Home Builders is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $900,000 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 returns in peoentage form are easier to understand and compare to required returns. Blue Moose Home Builders's WACC is 9%, and project Sigma 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 Sigma's IRR? Year Cash Flow Year $300,000 Year 2 $425,000 Year 3 $475,000 Year4 $450,000 21.82% 27.27% 24.54% 25.91% O O If this is an independent project, the IRR method states that the firm should If mutually exclusive projects are proposed that both have an IRR greater than the necessary WACC, the IRR method states that the firm should accept: O The project with the greatest IRR, assuming that both projects have the same risk as the firm's average O The project that requires the lowest initial investment, assuming that both projects have the same risk as the O The project with the greater future cash inflows, assuming that both projects have the same risk as the firm's project firm's average project average project

Explanation / Answer

Option B

0=-900000+300000/(1+IRR)+425000/(1+IRR)^2+475000/(1+IRR)^3+450000/(1+IRR)^4

So, IRR=27.27%

Accept the project because IRR is greater than MARR, or cost of capital (WACC) of 9%

Accept the prject with the highest IRR if both projects have IRR>WACC

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