Question

Consider a project with a cost of $1000, with the following expected cash inflows, and a WACC of 16%.

YEAR 1 $300--Year 2 $400- year 3 $300- Year 4 $500

Show your calculations by way of formulas, numerical values and if you like also by EXCEL for the following.

A. Calculate the present value of cash inflows.

B. Calculate the net present value of cash inflows.

C. Calculate the internal rate of return IRR.

D. Calculate the modified internal rate of return MIRR.

E. You will notice that IRR and MIRR are different in numerical values. Explain (in 5 lines) as to why they are different.

F. If you have to make a decision solely based on IRR or MIRR, which one would you choose and why? Explain in 5 lines.

Make sure you include your calculations by way of formulas, numerical values

Answer 1

Answers

A. PV of cash flows = ($258.62 + $297.27 + $192.20 + $276.15) i.e. $1,024.23

B. NPV of cash flows = $1024.23 - $1000 i.e. $24.23

C. IRR = 17.13%

D. MIRR = 16.70%

E. IRR indicates the internal rate of return that the project is giving from the investment whereas MIRR indicates the modified internal rate of return which states that the invested money will be reinvested during the life of project so due to reinvestment the pv will reduce from the project and so the MIRR is lower then IRR. A project life is 4 years the money in the end of year1 we get will be assumed to be reinvested again and same in year 2 and so on.

F. Since we doont keep our money idle and we would like to reinvest it to earn more. This is the basic concept of fiinance and so tthis concept is a like to MIRR and so i bilieve that MIRR is more logical then IRR and hence we should make decision in terms of MIRR. In the given case MIRR of the project is 16.70% and our requirent is 16% and hence the project is giving more then our requirement and so we should accept the project.