A firm evaluates all of its projects by applying the IRR rule. The current proposed project has cash flows of -$27,048, $16,850, $15,700, and $4,300 for years 0 to 3, respectively. The required return is 19 percent. What is the project IRR

A firm evaluates all of its projects by applying the IRR rule. The current proposed project has cash flows of -$27,048, $16,850, $15,700, and $4,300 for years 0 to 3, respectively. The required return is 19 percent. What is the project IRR? Should the project be accepted or rejected?

-16.05 percent; accept

-21.08 percent; reject

-18.30 percent; accept

-21.08 percent; accept

-16.05 percent; reject

The answer is: 21.08 percent; accept

Explanation:

The internal rate of return (IRR) is the discount rate that makes the net present value of a project equal to zero. The net present value(NPV) of a project is the discounted value of all future cash outflows. In this question IRR is calculated via the NPV as follows:

NPV = CF/(1+IRR)^t where t is the time period. Using the given percentage rates, we would carry out the following calculation for each year (year 0 to year 3) at each percentage rate given to determine which rate makes the NPV equal to zero.

Year 0 = - ($27, 048/(1 + 0.2108)^0) = - ($27, 048)

Year 1 = ($16, 850/(1 + 0.2108)^1) = $13, 916.42

Year 2 = ($15, 700/(1 + 0.2108)^2) = $10, 709.15

Year 3 = ($4, 300/(1 + 0.2108)^3) = $2, 422.43

$0

The IRR of 21.08% exceeds the required return of 19% therefore the project is profitable and should be accepted. The IRR model does not take into account the cost of capital and it assumes that all cash flows over the life of the project are reinvested at the IRR.