Question

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:

Green Caterpillar Garden Supplies Inc. is analyzing a project that requires an initial investment of $2,500,000. The project’s expected cash flows are:

Year |
Cash Flow |
---|---|

Year 1 | $350,000 |

Year 2 | –125,000 |

Year 3 | 500,000 |

Year 4 | 475,000 |

Green Caterpillar Garden Supplies Inc.’s WACC is 9%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR):

26.25%

30.39%

-13.28%

31.77%

If Green Caterpillar Garden Supplies Inc.’s managers select
projects based on the MIRR criterion, they should
**REJECT/ACCEPT** this independent project.

Which of the following statements about the relationship between the IRR and the MIRR is correct?

A typical firm’s IRR will be less than its MIRR.

A typical firm’s IRR will be greater than its MIRR.

A typical firm’s IRR will be equal to its MIRR.

Answer #1

Cash Flows:

Year 0 = -$2,500,000

Year 1 = $350,000

Year 2 = -$125,000

Year 3 = $500,000

Year 4 = $475,000

WACC = 9%

Present Value of Cash Outflows = $2,500,000 +
$125,000/1.09^2

Present Value of Cash Outflows = $2,605,209.999

Future Value of Cash Inflows = $350,000*1.09^3 + $500,000*1.09 +
$475,000

Future Value of Cash Inflows = $1,473,260.15

MIRR = (Future Value of Cash Inflows / Present Value of Cash
Outflows)^(1/Period) - 1

MIRR = ($1,473,260.15 / $2,605,209.999)^(1/4) - 1

MIRR = 0.565505^(1/4) - 1

MIRR = 0.8672 - 1

**MIRR = -0.1328 or -13.28%**

If Green Caterpillar Garden Supplies Inc.’s managers select
projects based on the MIRR criterion, they should
**reject** this independent project.

**A typical firm’s IRR will be greater than its
MIRR.**

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:
Green Caterpillar Garden Supplies Inc. is analyzing a project
that requires an initial investment of $400,000. The project’s
expected cash flows are:
Year...

4. Modified internal rate of return (MIRR)
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:
Green Caterpillar Garden Supplies Inc. is analyzing a project
that requires an initial investment of $3,225,000....

4. Modified internal rate of return (MIRR)
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:
Green Caterpillar Garden Supplies Inc. is analyzing a project
that requires an initial investment of $2,500,000....

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...

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...

Modified internal rate of return (MIRR)
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:
Fuzzy Button Clothing Company is analyzing a project that
requires an initial investment of $500,000. The project’s...

4. Modified internal rate of return (MIRR)
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:
Cold Goose Metal Works Inc. is analyzing a project that requires
an initial investment of $500,000....

8. Modified internal rate of return (MIRR)
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 :
Cute Camel Woodcraft Company is analyzing a project that
requires an initial investment of $3,225,000....

Cute Camel Woodcraft Company is analyzing a project that
requires an initial investment of $2,750,000. The project’s
expected cash flows are:
Year
Cash Flow
Year 1
$350,000
Year 2
–125,000
Year 3
400,000
Year 4
500,000
Cute Camel Woodcraft Company’s WACC is 9%, and the project has
the same risk as the firm’s average project. Calculate this
project’s modified internal rate of return (MIRR):
19.63%
-16.48%
27.71%
25.40%
If Cute Camel Woodcraft Company’s managers select projects based
on the MIRR...

The net present value (NPV) and internal rate of return (IRR)
methods of investment analysis are interrelated and are sometimes
used together to make capital budgeting decisions.
Consider the case of Green Caterpillar Garden Supplies Inc.:
Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a
portion of its planning and financial data when both its main and
its backup servers crashed. The company’s CFO remembers that the
internal rate of return (IRR) of Project Zeta is 14.6%, but he
can’t...

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