4. Modified internal rate of return (MIRR) s Aa The IRR evaiuation method assume

Question

4. Modified internal rate of return (MIRR) s Aa The IRR evaiuation 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 project's TRR Consider the following situation: Blue Llama Mining Company is analyzing a project that requires an initial investment of $400,000. The project's expected cash flows are: Year Cash Flow Year 1 $275,000 Year 2 -200,000 Year 3 475,000 Year 4 425,000 Blue Llama Mining Company's WACC is 8%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR) 17.95% 24.68% 25.81% 22.44% Q If Blue Llama Mining Company's managers select projects based on the MIRR criterion, they should independent project. this Which of the following statements best describes the difference between the IRR method and the MIRR method? ·The IRR method uses the present value of the initial investment to calculate the IRL The MIRR method uses O The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method O The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and the terminal value of the initial investment to calculate the MIRR assumes that cash flows are reinvested at a rate of return equal to the cost of capital. cash outflows to calculate the MIRR

Explanation / Answer

FV of cash inflows at t=4: 275000*1.08^3+475000*1.08+425000=1284421
PV of cash outflows at t=0: 400000+200000/1.08^2=571467.8

MIRR=(1284421/571467.8)^(1/4)-1=22.4416%

Accept the project as MIRR is greater than the cost of capital, WACC of 8%

IRR assumes that cash flows are reinvested at IRR whereas MIRR assumes cash flows are reinvested at cost of capital, WACC

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