Question

As a separate project (Project P), the firm is considering sponsoring a pavilion at the upcoming World’s Fair. The Pavilion would cost $900,000, and it is expected to result in $5.5 million of incremental cash inflows during its 1 year of operation. However, it would then take another year, and $5 million of costs, to demolish the site and return it to its original condition. Thus, Project P’s expected net cash flows look like this (in millions of dollars):

Year 0 1 2

Year	Net Cash Flows
0	($0.9)
1	5.5
2	(5.0)

The project is estimated to be of average risk, so its cost of capital is 10 percent. ( Without using Excel & Financial Calculator )

(1) What is Project P’s NPV? What is its MIRR?

(2) Does Project P have normal or non-normal cash flows? Should this project be accepted?

Answer 1

Solution:

Given information-

Year	0	1	2
Cashflows	-0.9	5.5	-5
Cost of capital	10%

1) NPV = Sum of present value of all the cashflows = [-0.9/(1.1)^0] + [5.5/(1.1)^1] + [-5/(1.1)^2]
= -0.9 + 5 - 4.132231405
= -0.032231405
= -$32,231.405

MIRR = [(Future value of positive cash flows / present value of negative cash flows)^(1/n)] – 1
Future value of positive cash flows = 5.5 * (1.1)^1 = 6.05
Present value of negative cash flows = [-0.9/(1.1)^0] + [-5/(1.1)^2] = = -0.9 - 4.132231405 = -5.032231405
So, MIRR = [(6.05/5.032231405)^(1/2)] - 1 = 1.0964716 - 1 = 0.09647 = 9.647%

2) Project P has non-normal cash flows as there other than initial outlay there is another outflow on the net basis at year 2. So, the sign of the cashflow changes sign twice first from -ve in period 0 to +ve in period 1 and then again from +ve in period 1 to -ve in period 2.

This projected should not be accepted as its NPV is negative and even MIRR is less than given rate of 10%.