Your firm has an average-risk project under consideration. You choose

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm’s existing capital structure.

If the cost of debt is 9.00%, the cost of preferred stock is 12.00%, the cost of common stock is 16.00%, and the WACC adjusted for taxes is 14.00%, what is the IRR of the project given the expected cash flows listed here? Use a financial calculator to determine your answer.

Category T0 T1 T2 T3
Investment -$2,000,000
NWC -$250,000 $250,000
Operating Cash Flow $850,000 $850,000 $850,000
Salvage $50,000
Total Incremental Cash Flow -$2,250,000 $850,000 $850,000 $1,150,000

A) About 12.13%
B) About 14.00%
C) About 24.95%
D) There is not enough information to answer this question.

ANSWER

Answer: A
Explanation: A) In this problem we have divided the T3 payment into two parts to facilitate ease of calculation. To solve for the IRR, input the following values:
PMT = $850,000, FV = $300,000, N = 3, PV = -$2,250,000, and solve for I% to get the IRR = 12.125% or “about 12.13%.”
Diff: 3