Question

Your company is considering the following three projects.

CF0 CF1 CF2 CF3 CF4

Project Whiskey -100 80 20 80 20

Project Tango -100 20 80 20 80

Project Foxtrot -100 50 50 50 50

1) What is Project Foxtrot’s MIRR? And, should the project be accepted if we used MIRR as the basis of decision? Assume that the cost of capital is 8%. Show your calculator inputs (CF0=?, CF1=?, CF2=?, CF3=?, CF4=?, etc.) to receive full credit.

2) What is Project Whiskey’s payback period? Should the project be accepted if the maximum payback period is 3.90 years? Show your work to receive full credit.

3) What is Project Whiskey’s discounted payback period if our WACC is 8%? Should the project be accepted if the maximum payback period is 4.05 years? Show your work to receive full credit.

Answer 1

Answer 1)

If the MIRR for Project Foxtrot is ‘i’, then

NPV (i) = -100 + 50/(1+i) + 50/(1+i)^2 + 50/(1+i)^3 + 50/(1+i)^4 = 0

NPV (8%) = -100 + 50/(1+8%) + 50/(1+8%)^2 + 50/(1+8%)^3 + 50/(1+8%)^4

NPV (8%) = -100 + 46.3 + 42.87 + 39.69 + 36.75 = 65.61

NPV (20%) = -100 + 50/(1+20%) + 50/(1+20%)^2 + 50/(1+20%)^3 + 50/(1+20%)^4

NPV (20%) = -100 + 41.67 + 34.72 + 28.94 + 24.11 = 29.44

NPV (30%) = -100 + 50/(1+30%) + 50/(1+30%)^2 + 50/(1+30%)^3 + 50/(1+30%)^4

NPV (30%) = -100 + 38.46 + 29.58 + 22.76 + 17.51 = 8.31

NPV (35%) = -100 + 50/(1+35%) + 50/(1+35%)^2 + 50/(1+35%)^3 + 50/(1+35%)^4

NPV (35%) = -100 + 37.04 + 27.43 + 20.32 + 15.05 = -0.14

By interpolation

‘i’ = 30% + (35% - 30%) * ((0-8.31)/(-0.14-8.31)) = 30% + 5% * .98227 = 34.91%

Since cost of capital is 8% and MIRR is 34.91% which is higher than 8%, project should be accepted

Answer 2) Below is the cash flow table for Project Whiskey:

Time	Project Whiskey	Cumulative Cash Flow
0	-100	-100
1	80	-20
2	20	0
3	80	80
4	20	100

Since, Cumulative cash flow at the end of period 2 is 0 it means payback period of Project Whiskey is 2 years.

If the maximum threshold to accept the project is 3.9 years, project whiskey should be accepted.

Answer 3) Below is the calculation of accumulated discounted cash flow for Project Whiskey:

Time	Project Whiskey	Discounted Cash Flow	Accumulated Discounted Cash Flow
0	-100	-100	-100
1	80	74.07	-25.93
2	20	17.15	-8.78
3	80	63.51	54.73
4	20	14.7	69.43

Since. Project Whiskey’s cash flows are becoming positive in 3^rd year

Discounted Payback Period = 2 years + (8.78/63.51) = 2.1382 years

If the maximum threshold to accept the project is 4.05 years, project whiskey should be accepted.