Question

Fuzzy Button Clothing Company is analyzing a project that requires an initial investment of $3,225,000. The project’s expected cash flows are:

Year	Cash Flow
Year 1	$375,000
Year 2	-175,000
Year 3	$425,000
Year 4	$450,000

Fuzzy Button Clothing Company’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):

A. 17.33% B.14.85% C.-20.01% D.18.15%

If Fuzzy Button Clothing Company’s managers select projects based on the MIRR criterion, they should Accept or Reject this independent project.

Which of the following statements about the relationship between the IRR and the MIRR is correct?

A typical firm’s IRR will be greater than its MIRR.

A typical firm’s IRR will be equal to its MIRR.

A typical firm’s IRR will be less than its MIRR.

Answer 1

Statement showing FV of cash inflows

Year	Cash flow	FVIF @ 8%	Future Value
1	375000	1.2597	472392
2		1.1664	0
3	425000	1.0800	459000
4	450000	1.0000	450000
FV of cash inflow	1381392

Statement showing PV of cashout flow

Year	Cash flow	PVIF @ 8%	Present Value
0	3225000	1.0000	3225000
1		0.9259	0
2	175000	0.8573	150034
PV of cash outflow	3375034

MIRR =[ PV of cash inflow/PV of cash outflow]^(1/n) - 1

=[1381392/3375034]^(1/4) - 1

=0.4093^0.25-1

=0.79985 - 1

= -0.2001

ie -20.01%

Ans c) -20.01%

2) The project should be rejected

3) A typical firm’s IRR will be greater than its MIRR.