The internal rate of return IRR refers to the compound annua

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 cash flows. Consider the case of Blue Pencil Publishing: Consider the following case Blue Pencil Publishing is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $800,000 Blue Pencil Publishing 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 Pencil Publishing\'s WACC is 796, 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 projedt Sigma\'s IRR? Year Cash Flo Year 1 $275,000 Year 2 $400,000 Year 3 $500,000 Year 4 $400,000 ? 31.09% 29.54% ? 24.87% O 27.98% 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 greater future cash inflows, assuming that both projects have the same risk as the firm\'s O The project that requires the lowest initial investment, assuming that both projects have the same risk as the O The project with the greatest IRR, assuming that both projects have the same risk as the firm\'s average average project firm\'s average project project

Solution

Let irr be x%
At irr,present value of inflows=present value of outflows.

800,000=275000/1.0x+400,000/1.0x^2+500,000/1.0x^3+400,000/1.0x^4

Hence x=irr=31.09%(Approx).

Hence since irr is greater than WACC;firm should accept the project.

When both projects have irr greater than WACC;project having highest irr should be accepted which would provide highest value addition to the company.Hence the correct option is C.