The IRR evaluation method assumes that cash flows from the project are reinveste

Question

The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the projects IRR. Consider the following situation: Cute Camel Woodcraft Company is analyzing a project that requires an initial investment of S2,225,000. The projects expected cash flows are: Cute Camel Woodcraft Companys WACC is 8%, and the project has the same risk as the firms average project. Calculate this projects modified internal rate of return (MIRR). If Cute Camel Woodcraft Companys managers select projects based on the MIRR criterion, they should this independent project. Which of the following statements about the relationship between the IRR and the MIRR is correct? A typical firms IRR will be greater than its MIRR. A typical firms IRR will be equal to its MIRR. A typical firms IRR will be less than its MIRR.

Explanation / Answer

MIRR =-13.98

Project should not be Accepted

A project's MIRR is always less than its regular IRR.

Cash flow Year0 -2225000 Year1 300000 Year2 -200000 Year3 425000 Year4 475000 MIRR -13.98%

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