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: Blue Llama Mining Company 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 Year 2 Year 3 Year 4 $300,000 -200,000 500,000 450,000 Blue Llama Mining Company's WACC is 7%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR): O 16.14% 0 21.84% 0 20.89% 0 -17.54% If Blue Llama Mining Company's 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? O A typical firm's IRR will be equal to its MIRR. O A typical firm's IRR will be less than its MIRR. O A typical firm's IRR will be greater than its MIRR.

Answer 1

Year CF Year CF 0 $ (2,750,000.000 -2750000 1 $ 300,000.00 1 300000 2 $ (200,000.00) 2 -200000 3 $ 500,000.00 3 500000 4 $ 450,000.00 4 450000 MIRE -17.54% MIRR =MIRR(B2:B6,7%,7%)

Reject

A typical firm's IRR will be greater than its MIRR