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 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 Cash Flow Year Sigma's IRR? $275,000 Year 1 O 24.17% Year 2 $400,000 25.51% Year 3 $450,000 O 22.82% $425,000 Year 4 O 26.85% 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 project The project with the greater future cash inflows, assuming that both projects have the same risk as the firm's average project O The project that requires the lowest initial investment, assuming that both projects have the same risk as the firm's average project The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Fuzzy Button Clothing Company: Last Tuesday, Fuzzy Button Clothing Company lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Delta is 11.3%, but he can't recall how much Fuzzy Button originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Delta. They are: Year Cash Flow Year 1 $1,800,000 Year 2 $3,375,000 Year 3 $3,375,000 Year 4 $3,375,000 The CFO has asked you to compute Project De lta's initial investment using the information currently available to you He has offered the following suggestions and observations: A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Delta is the same as that exhibited by the company's average project, which means that Project Delta's net cash flows can be discounted using Fuzzy Button's 8% WACC Given the data and hints, Project Delta's initial investment is , and its NPV is (rounded to the nearest whole dollar) if the project's cash inflows decrease, and everything else is unaffected A project's IRR will The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project's IRR. Consider the following situation: Cold Goose Metal Works Inc. is analyzing a project that requires an initial investment of $400,000. The project's expected cash flows are: Cash Flow Year $300,000 Year 1 -125,000 Year 2 Year 3 500,000 Year 4 425,000 Cold Goose Metal Works Inc.'s WACC is 8%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR): 24.80% 23.43% O 30.32% O 27.56% If Cold Goose Metal Works Inc.'s managers select projects based on the MIRR criterion, they should this independent project Which of the following statements best describes the difference between the IRR method and the MIRR method? The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR. O The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital. O The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR