5. Suppose your firm is considering investing in a project with the cash flows s

Question

5. Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively.

   Time: 0              1              2              3              4              5              6

Cash flow          –$15,000              $2,800   $4,000   $3,200   $3,200   $3,000   $2,800

Use the MIRR decision rule to evaluate this project.(Do not round intermediate calculations and round your final answer to 2 decimal places.)

6. Compute the PI statistic for Project Z if the appropriate cost of capital is 6 percent. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

   Project Z                                                                                         

Time:   0              1              2              3              4              5

Cash flow          $-3,400 $750       $880       $1,050   $700       $500

Explanation / Answer

(5)

MIRR = (Sum of terminal cash flows / Initial investment)1/n - 1

So, MIRR = ($23,359.63 / $15,00)1/6 - 1 = (1.5573)1/6 - 1 = 1.0766 - 1 = 0.0766, or 7.66%

Since MIRR < Required rate of return (8%), project should not be accepted.

NOTE: First question is answered.

Year Cash Flow ($) Future value factor @8% Terminal cash flow ($) (A) (B) (C) 1 2,800 1.4693 4,114.12 2 4,000 1.3605 5,441.96 3 3,200 1.2597 4,031.08 4 3,200 1.1664 3,732.48 5 3,000 1.0800 3,240.00 6 2,800 1.0000 2,800.00 Sum of Terminal Cash Flow ($) = 23,359.63

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