Question

Cute Camel Woodcraft Company is analyzing a project that requires an initial investment of $500,000. The project's expected cash flows are: Year 1 Year 2 Year 3 Year 4 $275,000 -150,000 500,000 400,000 Cute Camel Woodcraft Company's WACC is 9%, and the project has the same risk as the firm's average project. Calculate this project's modified 21.06% 18.05% 19.06% 20.06% If Cute Camel Woodcraft 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 only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR. O 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. O 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.

Answer 1

Cash Flows:

Year 0 = -$500,000
Year 1 = $275,000
Year 2 = -$150,000
Year 3 = $500,000
Year 4 = $400,000

WACC = 9%

Present Value of Cash Outflows = $500,000 + $150,000/1.09^2
Present Value of Cash Outflows = $626,252

Future Value of Cash Inflows = $275,000*1.09^3 + $500,000*1.09 + $400,000
Future Value of Cash Inflows = $1,301,132.975

MIRR = (Future Value of Cash Inflows / Present Value of Cash Outflows)^(1/n) - 1
MIRR = ($1,301,132.975 / $626,252)^(1/4) - 1
MIRR = 2.077651^(1/4) - 1
MIRR = 1.2006 - 1
MIRR = 0.2006 or 20.06%

If Cute Camel Woodcraft Company’s managers select projects based on the MIRR criterion, they should accept this independent project.

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.