Activity 19 Capital Budgeting: IRR, MIRR, PI The purpose of this assignment is t

Question

Activity 19 Capital Budgeting: IRR, MIRR, PI The purpose of this assignment is to practice capital budgeting via IRR, MIRR, PI and cross-over rate Group Number Class meeting Morning / Afternoon You are (again) asked to evaluate a new tractor project for Deere. The engineers and marketing and accounting folks have pooled their efforts to generate the following expectations about the project's cash flows (FCFF). The WACC = 10%. t-01 9 10 CF 30 40 50 40 50 50 30 30 20 10 -200 What is the IRR of the project? What is the profitability index (PI) of the project? What is the project's MIRR? a) Do it "brute force" by compounding each cash inflow individually (to the end of the time line) and then summing these to construct TV. b) Devise a shortcut to calculate the TV, and then continue with the usual steps to calculate MIRR.

Explanation / Answer

a) IRR = Rate of return at which cost of project = Present value of future cash flows.

Cashflow diagram above. Do a trial and error method to discount the cashflows. (let's start with WACC).

Discount Factor = 1/(1+r)^n, r = required rate of return, n = Period (year)

NPV is positive i.e 26.21 as NPV @WACC is positive , IRR (at which NPV = 0, would be greater than 10%).

Let's try r = 13.5%,

NPV = -1 (<0) thus IRR should be less than 13.5%

Trying r = 13.25% NPV = 0.0085 (~0) Thus IRR = 13.25%

Years 0 1 2 3 4 5 6 7 8 9 10 Casflow -200 30 40 50 40 50 50 30 30 20 10

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