Question

The IRR evaluation method assumes that cash flows from the project are reinvested at a rate equal to the project’s IRR. However, in reality, the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, using the modified IRR approach, you can make a more reasonable estimate of a project’s rate of return than the project’s IRR can.

Consider the following situation:

Cold Goose Metal Works Inc. is analyzing a project that requires an initial investment of $500,000. The project’s expected cash flows are:

Year	Cash Flow
Year 1	$375,000
Year 2	–175,000
Year 3	400,000
Year 4	475,000

Cold Goose Metal Works Inc.’s WACC is 7%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR)__________________?

A. 19.18%

B. 20.19%

C. 23.22%

D. 21.20%

If Cold Goose Metal Works Inc.’s managers select projects based on the MIRR criterion, they should______________this independent project.

Which of the following statements best describes the difference between the IRR method and the MIRR method?

A. The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR.

B. The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR.

C. The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

Answer 1

Answer : Correct Option is (B.) 20.19%

Below is the sheet showing calculation of MIRR

If Cold Goose Metal Works Inc.’s managers select projects based on the MIRR criterion, they should accept this independent project as it has MIRR more than WACC

Correct Option is C. The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.