Question

Carriage Inc., a steel manufacturing company, is planning to buy a new plant. The internal rate of return provided by the new plant is 6%. The cost of capital for Carriage Inc. is 8%. Based on the given scenario, which of the following statements is true in the context of internal rate of return?a.Carriage Inc. should invest in the new plant because the project will earn more than zero IRR from the project.b.Carriage Inc. should not invest in the new plant because the IRR of the project is less than its cost of capital.c.Carriage Inc. should not invest in the new plant because IRR is not a reliable model for making capital investment decisions.d.Carriage Inc. should invest in the new plant because IRR is the true or actual simple rate of return that is earned by the initial investment.

Answer 1

Answer:

Carriage Inc. should not invest in the new plant because the IRR of the project is less than its cost of capital.

Explanation:

The investment should NOT be made in the new plant because its internal rate of return is lower than Carriage's cost of capital.

In simple language since the return (IRR) that will be gotten from the new plant is LOWER than the cost (cost of capital), then the company is not making a profit if it invests in this new plant.

Generally, as a decision rule, a company should only invest when the IRR is higher than (or equal to) its cost of capital.