Question

Blue Llama Mining Company is analyzing a project that requires an initial investment of $600,000. The project's expected cash flows are: Year Year 1 Cash Flow $275,000 Year 2 -125,000 Year 3 475,000 Year 4 500,000 Blue Llama Mining Company's WACC is 10%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR): 17.61% 20.39% 18.54% 19.47% If Blue Llama Mining 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 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. 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. 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.

Answer 1

-600,000.00 $ 1 275,000.00 $ 2 -125,000.00 $ 3 475,000.00 $ 500,000.00 Blue Llama Mining Co Cash flows WACC PV of cash outflows FV of cash inflows MIRR $ 10% -703,305.79 $ 1,388,525.00 18.54% -600,000.00 $ $ $ -103,305.79 $ 366,025.00 $ 522,500.00 $ 500,000.00

Based on MIRR criterion, they should accept the project as MIRR > WACC

IRR method assumes that the cash flows are reinvested at IRR, where as MIRR assumes that the cash flows are reinvested at rate of return equal to cost of capital.

Formulae

B с D E F G 3604 Blue Llama Mining JO 1 2 3 3605 Cash flows -600000 275000 125000 475000 500000 3606 WACC 0.1 3607 PV of cash outflows =SUM(C3607:E3607) =C3605/(1+B3606) C3604 =E3605/(1+B3606)^E3604 3608 FV of cash inflows =SUM(C3608:G3608) =D3605*(1+$B$3606)^($G$3604-D3604) =F3605*(1+$B$3606)^($G$3604-F3604) =G3605*(1+$B$3606)^($G$3604-G3 3609 MIRR =C-B3608/B3607)^(1/G3604) - 1