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 $3,000,000. The project's expected cash flows are: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $300,000 -125,000 450,000 400,000 Celestial Crane Cosmetics'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). 0 -20.14% 021.31% O 15.10% O 16.87% this If Celestial Crane Cosmetics's managers select projects based on the MIRR criterion, they should independent project. Which of the following statements about the relationship between the IRR and the MIRR is correct? O O O A typical firm's IRR will be greater than its MIRR. A typical firm's IRR will be less than its MIRR. A typical firm's IRR will be equal to its MIRR.

Answer 1

A B C D E F G H Year 0 2 3 Cash flows -3000000 300000 -125000 450000 400000 8% -20.14% WACC MIRR Modified internal rate of return (MIRR) = -20.14% If celestial crane cosmetics's managers select projects based on the MIRR criterion, they should reject this independent project. Relationship between the IRR and the MIRR: A typical firm's IRR will be greater than its MIRR.

EXCEL FORMULA:

в с Year 1 Cash flows - 3000000 300000 - 125000 450000 400000 0.08 =MIRR(C3:C7, C8,08) WACC MIRR Modified internal rate of return (MIRR) = -20.14%