Should The Flour Baker Accept This Project Based on Its Internal Rate of Return?

Question:

Should The Flour Baker accept the project with the given cash flows if the required return is 18 percent?

Multiple Choice:

a) Yes; because the project's rate of return is 7.78 percent

b) Yes; because the project's rate of return is 16.08 percent

c) Yes; because the project's rate of return is 19.47 percent

d) No; because the project's rate of return is 19.47 percent

e) No; because the project's rate of return is 16.08 percent

Answer:

The Flour Baker should not accept this project based on its internal rate of return.

Explanation:

The Cash Flows:

The project involves cash flows of -$49,000 at Year 0, $9,500 at Year 1, $26,200 at Year 2, and $38,700 at Year 3.

Calculating Internal Rate of Return (IRR):

The required return for this project is 18 percent. To determine if the project should be accepted based on its IRR, we need to calculate the IRR and compare it to the required return.

To calculate the IRR, we need to find the discount rate that makes the present value of the cash inflows equal to the initial investment. By discounting each cash flow back to Year 0 and summing them, we can solve for the discount rate that makes the net present value (NPV) equal to zero.

Using financial calculator or spreadsheet software, the IRR for this project is approximately 16.08 percent, which is lower than the required return of 18 percent.

Therefore, based on its IRR being lower than the required return, The Flour Baker should not accept this project.