Question

You are considering a mining project in which you need to invest $ 2 millions and you get back annual cash flows of $ 1.1 million for 3 years. After that, the project is going to end; so you are required to expend $ 1 million in soil restauration in year 4. The required return is 8%.

A) Find one of the project's IRR.

B) How many IRR’s are possible to find for this project? Explain.

C) Based on IRR, would you approve this project? Is the project acceptance based on IRR necessarily correct? Explain.

D) Calculate the Profitability Index for this project. Would you accept the project based on Profitability Index? Why? Justify.

Answer 1

A) We find IRR using excel function IRR

Hence, one of the project's IRR = 12.29%

B) The sign on the cash-flow changes two times in 4 years. Hence, there are 2-IRR's possible.

C) Yes, the IRR is greater than the required return of 8%. Hence, the project should be accepted.

No, since there is a multiple IRR problem, it can be said that project acceptance based on IRR not necessarily correct

D) Profitability Index = PV of future-cashflows/Initial investment

Profitability Index = 1.0498

Since, the index is greater than 1, the project can be accepted on basis of Profitability Index. This is because the future cash-flows are greater than the intial invested discounted basis required return.