The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project’s IRR.
Consider the following situation:
Blue Llama Mining Company is analyzing a project that requires an initial investment of $450,000. The project’s expected cash flows are:
Year |
Cash Flow |
---|---|
Year 1 | $375,000 |
Year 2 | –125,000 |
Year 3 | 400,000 |
Year 4 | 400,000 |
Blue Llama Mining Company’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):
23.18%
20.86%
22.02%
25.50%
If Blue Llama Mining Company’s managers select projects based on the MIRR criterion, they should (accept or reject?) this independent project.
Which of the following statements best describes the difference between the IRR method and the MIRR method?
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.
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.
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.
Based on the given data, pls find below workings:
Assumption: Have assumed both cost of capital and Investment rate as 7%;
Based on the workings, the MIRR % = 23.18%; Based on the MIRR criteria as well as using other factors of Capital Budegting, this Project is recommended for investment.
Which of the following statements best describes the difference between the IRR method and the MIRR method?
This is the correct Statement:
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.
Currency in $ | ||||||
YEAR | 0 | 1 | 2 | 3 | 4 | |
Cash Flows | -4,50,000 | 3,75,000 | -1,25,000 | 4,00,000 | 4,00,000 | |
Cumulative Cash flows | -4,50,000 | -75,000 | -2,00,000 | 2,00,000 | 6,00,000 | |
12 | 12 | 6 | ||||
Pay Back Period | 2.5 | |||||
IRR % | 40.6% | |||||
IRR % | 23.18% | |||||
Discounting Factor | 7.00% | |||||
YEAR | 0 | 1 | 2 | 3 | 3 | |
Discounting Factor | 1.0000 | 0.9346 | 0.8734 | 0.8163 | 0.7629 | |
NPV | ||||||
Discounted Cash Flow | -4,50,000 | 3,50,467 | -1,09,180 | 3,26,519 | 3,05,158 | 4,22,965 |
Cumulative Discounted Cash flows | -4,50,000 | -99,533 | -2,08,713 | 1,17,807 | 4,22,965 | |
12 | 12 | 8 | -5 | |||
Discounted Pay Back Period | 2.3 |
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