Question

You are getting ready to start a new project that will incur some cleanup and shutdown costs when it is completed. The project costs

$5.36

million up front and is expected to generate

$1.13

million per year for

10

years and then have some shutdown costs at the end of year

11.

Use the MIRR approach to find the maximum shutdown costs you could incur and still meet your cost of capital of

14.8%

on this project.

Answer 1

Cashinflow = $1.13million

Upfront Cost = $5.36million

Number of year inflow is 10years

Cost of capital = 14.8%

To accept project with maximum shutdown cost Present Value of Cashinflow should be equal to Present Value Cashoutflow

Initially Project+ Shutdown Cost = Annual Cash inflow

Annual Cashinflow = Cash inflow PVIFA ( Ke,10)

Annual Cashinflow = $1.13million ( 14.8%,10)

Annual Cashinflow = $1.13million × 5.0573

Annual Cashinflow =$5.714million

Initial Project cost + Shutdown cost = Annual Cashinflow

$5.34million + X × ( 14.8%,11) = $5.714million

X × 0.2191 = $5.71million - $5.34million

X × 0.2191 =$0.374million

X = $0.374 million / 0.2191

X = $1.71 million

Maximum shutdown cost would be $1.71 million.

(Working note PVIFA ( 14.8%,10)

= (1/(1+14.8%)^1 + 1/(1+14.8%)^2 +1/(1+14.8%)^3 +1/(1+14.8%)^4 +1/(1+14.8%)^5+ 1/(1+14.8%)^6 +1/(1+14.8%)^7 +1/(1+14.8%)^8 +1/(1+14.8%)^9 +1/(1+14.8%)^10)

= ( 0.871 + 0.758 + 0.661+ 0.576 + 0.502 + 0.437 + 0.381+ 0.331 + 0.289 + 0.256 )

PVIFA (14.8%,10) = 5.057)