Question

# 1.      Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown...

1.      Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.

 Time 0 1 2 3 Project A Cash Flow ?20,000 10,000 30,000 1,000 Project B Cash Flow ?30,000 10,000 20,000 50,000

Use the MIRR decision rule to evaluate these projects; which one(s) should be accepted or rejected?

A.      ACCEPT BOTH A AND B

B.       ACCEPT NEITHER A NOR B

C.       ACCEPT A, REJECT B

D.      REJECT A, ACCEPT B

Project A:

Future value of year 1 cash flow = 10000 (1 + 0.08)2 = 11,664

Future value of year 2 cash flow = 30000 (1 + 0.08)1 = 32,400

Future value of year 3 cash flow = 1000 (1 + 0.08)0 = 1000

Future value = 11,664 + 32,400 + 1000 = 45,064

MIRR = (FV / initial investment)1/n - 1

MIRR = (45,064 / 20,000)1/3 - 1

MIRR = 0.3110 or 31.10%

Project B:

Future value of year 1 cash flow = 10000 (1 + 0.08)2 = 11,664

Future value of year 2 cash flow = 20000 (1 + 0.08)1 = 21,600

Future value of year 3 cash flow = 50000 (1 + 0.08)0 = 50000

Future value = 11,664 + 21,600 + 50000 = 83,264

MIRR = (FV / initial investment)1/n - 1

MIRR = (83,264 / 30,000)1/3 - 1

MIRR = 0.4053 or 40.53%

D.      REJECT A, ACCEPT B