Question

Grey Fox Aviation Company is analyzing a project that requires an initial investment of $600,000. The project’s expected cash flows are:

Year Cash Flow

Year 1 $300,000

Year 2 –200,000

Year 3 400,000

Year 4 500,000

1.Grey Fox Aviation Company’s WACC is 10%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR):

15.02%

15.77%

14.27%

13.52%

2.If Grey Fox Aviation Company’s managers select projects based on the MIRR criterion, they should ACCEPT or REJECT this independent project.

3.Which of the following statements best describes the difference between the IRR method and the MIRR method?

a)The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR.

b)The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR.

c)The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

Answer 1

1.Grey Fox Aviation Company’s WACC is 10%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR):

15.02%

2.If Grey Fox Aviation Company’s managers select projects based on the MIRR criterion, they should ACCEPT this independent project. (Because MIRR is higher than WACC)

3.Which of the following statements best describes the difference between the IRR method and the MIRR method?

c)The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

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