Question

A capital investment project requires an initial investment of $100 and generates positive cash flows, $50 and $100, at the end of the first and second years, respectively. (There is no cash flow after the second year) The firm uses a hurdle rate of 15% for projects of similar risk.

Determine whether you should accept or reject the project based on NPV.

Determine whether you should accept or reject the project based on IRR.

Determine whether you should accept or reject the project based on MIRR.

Answer 1

Calculation of NPV:

Year	Expected cash flow	Present value @15%
0	(100)	(100)
1	50	43.4783
2	100	75.6144

NPV = 19.0927 i.e positive NPV Hence, project should be accepted.

Calculation of IRR of the project:

100=[50÷(1+r)]+[100÷(1+r)^2]

Following are steps of guessing r

Step:Compute excess cash flow per year=(50+100-100)/2=25

Step:Return on Initial Investment=(25/100)×100=25%

Step:Return on unrecovered investment balance=25×1.5=37.5

Step:Since cash flows are poor then reduce by 3% or 4%

At r = 32%

Right hand side = 39+58=97

Hence,IRR = 32%

Since approximate IRR is greater than hurdle rate this shows project should be accepted.

Calculation of MIRR:

(PV of return phase÷PV Of Initial Investment)this is under the root which is then multiplied by (1.15-1)

=square root of (119.0927/100)×(1.15-1)

=1.19092×.15

=.1786 or 17.86%