There are 2 investment funds that you read about in the Wall Street Journal, and

Question

There are 2 investment funds that you read about in the Wall Street Journal, and you would like to evaluate their payback periods. Cloaks requires an initial investment of $1,949, while Daggers requires a $2855 initial investment. The following are the cash flows estimates: Year Cloaks Daggers 1 $200.00 $400.00 2 $400.00 $600.00 3 $600.00 $800.00 4 $800.00 $1,200.00 5 $800.00 $1,400.00 6 $800.00 $1,600.00 7 $800.00 $1,800.00 Assuming an 8% required rate of return, what is the discounted payback on Cloaks What is the profitability index for Daggers? Assume an 8% required return. What is the MIRR for each?

Explanation / Answer

Year Cloakes Daggers PV Factor @8% PV Cloakes PV Daggers Cum Discounted Cum Discounted Future Value Future Value a b c a*b a*c Cloakes Daggers Cloakes Daggers 0 ($1,949) ($2,855) 1.0000 ($1,949) ($2,855) 1 $200 $400 0.9259 $185 $370 $185 $370 $317.37 $634.75 2 $400 $600 0.8573 $343 $514 $528 $885 $587.73 $881.60 3 $600 $800 0.7938 $476 $635 $1,004 $1,520 $816.29 $1,088.39 4 $800 $1,200 0.7350 $588 $882 $1,592 $2,402 $1,007.77 $1,511.65 5 $800 $1,400 0.6806 $544 $953 $2,137 $3,355 $933.12 $1,632.96 6 $800 $1,600 0.6302 $504 $1,008 $2,641 $4,363 $864.00 $1,728.00 7 $800 $1,800 0.5835 $467 $1,050 $3,108 $5,413 $800.00 $1,800.00 $5,326.29 $9,277.35 Discounted Payback Cloakes - It occurs between year 4-5 = 4 + (1949-1592) / 544 = 4.65 years Daggers - It occurs between year 4-5 = 4 + (2855 - 2402) /953 = 4.48 years MIRR Future Value of Inflows can be calculated using Compound Interest Formula = P * [(1+r)^n - 1] where, P is periodic inflow, r is WACC and n is time period Cloakes - Future Value of Inflows = $5326.29 MIRR = [(FV of Inflow / PV of Outflow)^1/n] - 1 = [(5326.29 / 1949) ^ 1/7] - 1 = (2.73283^1/7) - 1 = 1.15444 - 1 = 15.44% Daggers - Future Value of Inflows = $9277.35 MIRR = [(FV of Inflow / PV of Outflow)^1/n] - 1 = [(9277.35 / 2855) ^ 1/7] - 1 = (3.24951^1/7) - 1 = 1.18336 - 1 = 18.34%

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