Question

You are considering a mining project in which you need to invest $ 2 millions and you get back annual cash flows of $ 1.1 million for 3 years. After that, the project is going to end; so you are required to expend $ 1 million in soil restauration in year 4. The required return is 8%.

A) Find one of the project's IRR.

B) How many IRR’s are possible to find for this project? Explain.

C) Based on IRR, would you approve this project? Is the project acceptance based on IRR necessarily correct? Explain.

D) Calculate the Profitability Index for this project. Would you accept the project based on Profitability Index? Why? Justify.

Answer 1

1.
-2+1.1/(1+r)+1.1/(1+r)^2+1.1/(1+r)^3-1/(1+r)^4=0
=>r=12.2867%

2.
Two IRRs are possible as there are two sign changes and number of IRR is equal to number of sign changes in cash flows

3.
Based on IRR, approve the project as IRR is more than required return of 8%

The acceptance is not necessarily correct as there are multiple IRRs

4.
Profitability Index=(1.1/(1+8%)+1.1/(1+8%)^2+1.1/(1+8%)^3)/(2+1/1.08^4)=1.0364811

Accept as Profitability Index is more than 1