Question

As a separate project (Project P), the firm is considering sponsoring a pavilion at the upcoming World’s Fair. The Pavilion would cost $900,000, and it is expected to result in $5.5 million of incremental cash inflows during its 1 year of operation. However, it would then take another year, and $5 million of costs, to demolish the site and return it to its original condition. Thus, Project P’s expected net cash flows look like this (in millions of dollars):

Year 0 1 2

Year	Net Cash Flows
0	($0.9)
1	5.5
2	(5.0)

The project is estimated to be of average risk, so its cost of capital is 10 percent.

(1) What is Project P’s NPV? What is its MIRR?

(2) Does Project P have normal or non-normal cash flows? Should this project be accepted?

Answer 1

So 1.>

Year	Project P
0	-900000
1	5500000
2	-5000000
NPV	$ -32,231.40
	=NPV(0.1,Cash Flows from Year 1-2)-900000
MIRR	9.65%
	=MIRR(Cash Flows from Year 0-2,0.1,0.1)

Sol 2.>

Cash flows which change direction (sign) only once are known as normal cash flows. Here we have Cash outflow in year 0, then cash Inflow in year 1 and again cash outflow in year 2. Since the cash flow change its direction two times, this is a case of non-normal cash flow.

Since the NPV is negative, we should reject this project.

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