Question

In: Accounting

Big Inc. is considering Two Projects X and Y, whose cash flows are shown below. These...

Big Inc. is considering Two Projects X and Y, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates other methods.

WACC:

8.00%

Year

0

1

2

3

4

CFx

−$1,100

$450

$500

$100

$100

CFy

−$2,750

$625

$725

$800

$1,400
  1. What are the MIRR’s? Discuss the importance of the MIRR method over IRR.
  1. If these projects are mutually exclusive which should be selected and why? If they are in depended which project(s) should be selected and why?
  1. Discuss your results of the methods used above and make a recommendation on the projects to the CEO using the different methods?

Solutions

Expert Solution

Assuming REINVEST RATE- 0.08

MIRR = - 1

=    - 1

=5.41%

fv of cash inflows of CFx IN $
Year CASH FLOWS FV FACTOR @ 8% FORMULA FUTURE VALUE OF CASH INFLOWS
0 (1100)
1 450 1.2597 1.083 (reinvested for three more years) 450*1.2597 = 566.865
2 500 1.1664 1.082 583.20
3 100 1.08 1.081 108

4

 100 1 cannot be reinvested 100
TOTAL 1358

In MIRR we consider that inflow of one year is reinvested in next year at 8% in above case.

Year CASH FLOWS CFy FV FACTOR @ 8% FORMULA FUTURE VALUE OF CASH INFLOWS
0 (2750)
1 625 1.2597 1.083 (reinvested for three more years) 625*1.2597 = 787.3125
2 725 1.1664 1.082 845.64
3 800 1.08 1.081 864

4

 1400 1 cannot be reinvested 1400
TOTAL 3897

MIRR WITH ABOVE FORMULA = 9.10%

MIRR are rates which assume that the internal yearly cash inflows are reinvested at the given reinvestment rate of return i.e. 8% in above case.

IRR assumes that internal yearly cash inflows are reinvested at IRR rate which is rarely the case. Because such options of reinvestment are not readily available in the market.this is the biggest flaw of IRR method.

If this projects are mutually exclusive i.e. only one project can be selected CFy shouldbe selected as it have MIRR higher than CFx

If projects are dependent i.e. any or all projects can be selected Project CFy should be slected as CFx have MIRR lower than 8% of investment rate.

ekkarill92 answered 2 months ago
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