Question

2. You also have a second project that will also cost 1750 to invest in today, and will generate cash inflows of 300, 500, 590, and 1000 at the end of each of the next four years. If the discount rate is 10%, what is the MIRR and should you accept the project based on the MIRR? 2. You also have a second project that will also cost 1750 to invest in today, and will generate cash inflows of 300, 500, 590, and 1000 at the end of each of the next four years. If the discount rate is 10%, what is the MIRR and should you accept the project based on the MIRR?

Please show all your work

Answer 1

Here, the initial investment is 1750 which generate cash inflows of 300, 500, 590, and 1000 at the end of each of the next four years. The given discount rate is 10%. We need to evaluate the NPV and IRR of the project first for making an investment decision.

The concept of Modified Internal Rate of Return (MIIR) follows that the initial investment and the future values of the total latest cash flows are taken into consideration. So, we will compound the cash inflows at year 1,2, 3 and 4 to year 4 using this formula: FV = PV*(1+r)^n; where FV is future value, PV is present value, r is discount rate and n is the discount period. Once compounded to year 4, we will add all of them up and get the value 2653.60 at year 4. We will recalculate the NPV and IRR of the project. We find that the IRR has now changed to 10.97%. As per the theory, this new IRR is our MIRR.

So, MIRR = 10.97% (Also verified by Excel Formula: =MIIR(All_cash_flows,10%,10%) )

Eventhough MIRR has certain benefits compared to IRR, it is still a sub-optimal tool for making the investment decision just based on the MIRR as it requires making more investment related assumptions which is subjective in nature. So, while making an investment decision, it is always better to look for various alternatives and tools. In this case, along with the MIRR, we can also use the NPV to make the final investment decision.