Question

1.       Select the group of words missing from the statement below about the Modified Internal Rate of Return (MIRR).

“The MIRR allows for any ________ cash flows produced by an investment over the project period to be _________ at a chosen ________ rate rather than the _____ of the project. It also allows any _______ cash flows to be discounted back to the present time at the ________ rate to determine how much needs to be set aside today in order to fund future cash outflows.”

a)      Project, Discounted, Discount, NPV, Positive, Interest

b)      Positive, Discounted, Reinvestment, NPV, Negative, Interest

c)       Project, Reinvested, Discount, IRR, Positive, Finance

d)      Positive, Reinvested, Reinvestment, IRR, Negative, Finance

2.   Which of the following can be said to be some of the disadvantages of Capital Rationing?

a)      By using capital rationing techniques and investing only in selected projects, Capital Rationing effectively ignores the theory that managers should invest in all projects that add value to the company and increase shareholder wealth.

b)      Capital rationing allows all unprofitable projects to be accepted and so profits are not maximized.

c)       Capital rationing places restrictions on the cost of capital applied to project cash flows and the hurdle rates used to measure profitability.

d)      Capital rationing excludes from evaluation and the selection criteria, any intermediate cash flows from a project.

Answer 1

1. d) Positive, Reinvested, Reinvestment, IRR, Negative, Finance

MIRR assumes that positive cash flows from the investment on a new project are reinvested at the firm's cost of capital and not at IRR and the initial investments are financed at the firm's financial cost.

2. a), c), d)

By following capital rational, a firm invests only in certain projects and not in all the profitable projects violating efficient capital markets theory.

Selective criteria is applied while calculating cost of capital of shortlisted projects. The firm should accurately calculate cost of capital to avoid selecting less profitable poject.

Capital rational only considers the final returns from a project and excludes intermediate cashflows while evaluating a project