Question

2. Internal rate of return (IRR) The internal rate of retum (IRR) refers to the compound annual rate of return that a project generates based on its up-front cost and subsequent cash flows. Consider the case of Blue Llama Mining Company: Consider the following case: Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $850,000 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 returns in percentage form are easier to understand and compare to required returns. Blue Llama Mining Company's WACC is 8%, 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 1 $300,000 Year 2 $425,000 Year 3 $400,000 Year 4 $425,000 o 24.78% o 22.02% o 26.15% ? 27.53% If this is an independent project, the IRR method states that the firm should accept project Sigma ect Sigma ect