10.2.3

The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions.

Consider this case:

Suppose Hungry Whale Electronics is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $550,000. The project is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$375,000
Year 2	450,000
Year 3	450,000
Year 4	400,000

Hungry Whale Electronicss weighted average cost of capital is 8%, and project Alpha has the same risk as the firms average project. Based on the cash flows, what is project Alphas net present value (NPV)? (Note: Do not round your intermediate calculations.)

$1,384,261

$834,261

$959,400

$1,284,261

Hungry Whale Electronicss decision to accept or reject project Alpha is independent of its decisions on other projects. If the firm follows the NPV method, it should Select- Accept or Reject project Alpha.

10.2.4

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 this case:

Consider the following case:

Blue Llama Mining Company is evaluating a proposed capital budgeting project (project Delta) that will require an initial investment of $1,450,000.

Blue Llama Mining Company has been basing capital budgeting decisions on a projects 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 percentages and returns are easier to understand and to compare to required returns. Blue Llama Mining Companys WACC is 10%, and project Delta has the same risk as the firms average project.

The project is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$325,000
Year 2	$450,000
Year 3	$425,000
Year 4	$450,000

Which of the following is the correct calculation of project Deltas IRR?

4.11%

5.40%

5.14%

4.88%

If this is an independent project, the IRR method states that the firm should reject or accept project Delta. .

If the projects cost of capital were to increase, how would that affect the IRR?

The IRR would increase.

The IRR would decrease.

The IRR would not change.