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:

Cute Camel Woodcraft 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	$300,000
Year 2	–200,000
Year 3	475,000
Year 4	425,000

Cute Camel Woodcraft 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):

1)-18.08%

2)14.66%

3)21.07%

4) 19.24%

If Cute Camel Woodcraft 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?

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

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

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

Answer 1

B7 fac =MIRR(B2:B6,0.08,0.08) A B с 1 year N 3 Cash flows 0 $ 1 $ 2 $ 3 $ 4 $ 4 (2,750,000.00) 300,000.00 (200,000.00) 475,000.00 425,000.00 -18.08% Answer 1 5 6 7 MIRR 8 9 Reject the Project 10 11 A typical Firms IRR will be greater than its MIRR 12