The Internal Rate of Return Decision
Should The Flour Baker accept the project based on its internal rate of return of 7.78 percent, with a required return of 18 percent?
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 project should not be accepted because the project's rate of return is less than the required return.
Explanation:
The Internal Rate of Return (IRR) is a crucial metric in capital budgeting as it helps in making decisions regarding new projects or investments. In this case, The Flour Baker is evaluating a project with an IRR of 7.78 percent and a required return of 18 percent.
The IRR is the discount rate that makes the Net Present Value (NPV) of the project equal to zero. If the project's IRR is higher than the required return, it indicates that the project is expected to generate returns higher than the cost of capital. On the other hand, if the IRR is lower than the required return, the project may not be worth pursuing.
Given that the project's IRR is 7.78 percent, which is below the required return of 18 percent, it suggests that the project may not be profitable enough to justify the investment. Therefore, The Flour Baker should not accept this project based on its internal rate of return.
Understanding and analyzing the IRR of a project is crucial in making informed investment decisions and ensuring that the company's resources are allocated efficiently.