Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: CF0 = -6,000, CF1 = +3,300, CF2 = +3,300.
A) Accept, since IRR exceeds opportunity cost.
B) Reject, since opportunity cost exceeds IRR.
C) Accept, since opportunity cost exceeds IRR.
D) Reject, since IRR exceeds opportunity cost.
rsef
To evaluate the project using the Internal Rate of Return (IRR) criterion, we need to calculate the rate of return at which the net present value (NPV) of the project becomes zero. The IRR is the discount rate that makes the NPV zero.
Here is how you can calculate the IRR:
1. Write down the cash flows of the project: CF0 = -6,000, CF1 = +3,300, CF2 = +3,300.
2. Calculate the NPV at a discount rate equal to the opportunity cost of 10%:
NPV = -6,000 / (1 + 0.10)^0 + 3,300 / (1 + 0.10)^1 + 3,300 / (1 + 0.10)^2
3. Solve for the discount rate (IRR) that makes the NPV equal to zero. You can use trial and error, or you can use financial software or calculators to find the IRR value. In this case, the IRR is approximately 22.5%.
Now that we have calculated the IRR, we can compare it to the opportunity cost of 10%:
Since the IRR (22.5%) is greater than the opportunity cost (10%), this means that the project generates a rate of return that is higher than the opportunity cost. As a result, we would choose option D) "Reject, since IRR exceeds opportunity cost."