Question

Mass Waste Disposal Inc. is considering the construction of a facility at a cost of $20 million. The project will produce positive cash flows of $7 million per year for the next 4 years but the 5th and final year will have a net negative cash flow of $5 million. If the reinvestment rate is 10% and the cost of capital is 9%, the MIRR of this project is ________ and the project should be ________. (accepted/rejected) Show all work and explain for credit.

Answer 1

We have following cash flows for the project

Cash Flow of Project (in $ million)
Year	0	1	2	3	4	5
Cash flow	-20	7	7	7	7	-5

Reinvestment rate = 10%, Cost of capital = 9%

FV = Future value of cash inflows compounded at reinvestment rate

Then FV = 7(1+10%)⁴ + 7(1+10%)³ +7(1+10%)² +7(1+10%)¹ = 7 x 1.4641 + 7 x 1.331 + 7 x 1.21 + 7 x 1.1 = 10.2487 + 9.317 + 8.47 + 7.7 = 35.7357

PV = Present value of cash outlows discounted at cost of capital

Then PV = 20 + 5 / (1+9%)⁵ = 20 + 5/1.538624 = 20 + 3.249656 = 23.249656

We know that

MIRR = (FV /PV)^1/n - 1 = (35.7357 / 23.249656)^1/5 - 1 = (1.537042)^1/5 - 1 = 1.0897757 - 1 = 0.0897757 = 8.97757%

We get MIRR of the project = 8.97757%

Decision rule of MIRR is that if MIRR is greater than cost of capital then project should be accepted, otherwise it should be rejected.

As MIRR of the project is less than the cost of capital of the project, therefore project should not be accepted.