Question

4. Modified internal rate of return (MIRR) 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: Grey Fox Aviation Company is analyzing a project that requires an initial investment of $550,000. The project's expected cash flows are: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $375,000 -150,000 500,000 500,000 Grey Fox Aviation Company'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): 23.13% 25.44% 18.50% 21.97% If Grey Fox Aviation Company's managers select projects based on the MIRR criterion, they should this independent project. 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 IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR. The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital. The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR.

Answer 1

B36 ✓ fc =MIRR(B30:B34,10%,10%) C D E F 29 Year - X A B Cashflows 0$ (550,000) 1 $ 375,000 2 $ (150,000) 3 $ 500,000 4 $ 500,000 31 32 33 34 36 MIRR 23.13% 37 38 Project should be accepted. 39 40 Correct option is "The IRR method assumes that 41 42 cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to 43 the cost of capital."

Function Arguments ? X MIRR Values B30:334 Finance rate 10% 1 1 1 = {-550000;375000:-150000;500000;500000} = 0.1 = 0.1 Reinvest_rate 10% = 0.231294578 Returns the internal rate of return for a series of periodic cash flows, considering both cost of investment and interest on reinvestment of cash. Reinvest_rate is the interest rate you receive on the cash flows as you reinvest them. Formula result = 23.13% Help on this function D OK Cancel

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