Grey Fox Aviation Company is evaluating a proposed capital budgeting project (pr
ID: 1175779 • Letter: G
Question
Grey Fox Aviation Company is evaluating a proposed capital budgeting project (project Sigma) that will require an initial investment of $750,000. Grey Fox Aviation 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. Grey Fox Aviation Company's WACC is 10%, 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 Flo Year 1 $325,000 Year 2 $450,000 Year 3 $400,000 Year 4 $475,000 ? 30.73% 0 34.57% ? 38.41% o 36.49%Explanation / Answer
Let irr be x%
At irr,present value of inflows=present value of outflows.
750000=325000/1.0x+450000/1.0x^2+400,000/1.0x^3+475000/1.0x^4
Hence x=irr=38.41%(Approx).
Hence since irr is greater than WACC;firm should accept the project.
At irr,present value of inflows=present value of outflows.
Hence the firm having higher IRR would provide greater value addition and hence must be selected .Hence the correct option is B.
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