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 project’s IRR.

Consider the following situation:

Celestial Crane Cosmetics is analyzing a project that requires an initial investment of $2,750,000. The project’s expected cash flows are:

Year	Cash Flow
Year 1	$325,000
Year 2	–100,000
Year 3	425,000
Year 4	400,000

Celestial Crane Cosmetics’s WACC is 10%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR):

23.33%

17.78%

-17.69%

18.89%

Answer 1

Year 1 Cash flows $325,000 $0 $425,000 $400,000 Terminal value Fv @ 10% 1.3310 1.2100 1.1000 1.00 Future value $432,575.00 $0.00 $467,500.00 $400,000.00 $1,300,075.00 present value of cash outflow = $2,832,644.63 2750000+(100000/1.1^2) MIRR = (Terminal value of cash inflows/pv of out flow)^(1/t)-1 = -17.69% (1300075/2832644.63)^(1/4)-1