Question

A mining company is deciding whether to open a strip mine, which costs $2 million. Cash inflows of $13.5 million would occur at the end of Year 1. The land must be returned to its natural state at a cost of $11 million, payable at the end of Year 2. a. Plot the project's NPV profile. А B D NPV Million of Dolles NPV Milions of Dolas) NPV (Million of Delled) NPV Milions of Doles) 3 2.5 2 2.5 . 1.5 2.5 . 25 2.5 2 1.5 15 14 0.5 0.9 0.5 0.5 0.5 0.5 -0.5 0.5 0 100 200 300 400 WACC%) 100 200 300 400 WACC(%) 100 300 400 WACC%) 100 200 300 400 WACC(%) The correct sketch is B 4 b. Should the project be accepted if WACC = 10%? -Select- Should the project be accepted if WACC = 20%? -Select- c. Think of some other capital budgeting situations in which negative cash flows during or at the end of the project's life might lead to multiple IRRs. The input in the box below will not be graded, but may be reviewed and considered by your instructor. d. What is the project's MIRR at WACC = 10%? Round your answer to two decimal places. Do not round your intermediate calculations 'Yo What is the project's MIRR at WACC = 20%? Round your answer to two decimal places. Do not round your intermediate calculations. Does MIRR lead to the same accept/reject decision for this project as the NPV method? -Select- Does the MIRR method always lead to the same accept/reject decision as NPV? (Hint: Consider mutually exclusive projects that differ in size.) (-Select-

Answer 1

a). For cash flows of CF0 = -2; CF1 = 13.5; CF2 = -11, the NPV becomes zero at somewhere between 475% and 500% discount rate. For a discount rate of 0%, the NPV is -2 + 13.5 -11 = 0.5 million. So, the correct NPV profile is profile (B).

b). NPV (@10%) = -2 + 13.5/(1+10%) -11/(1+10%)^2 = 1.18 million

NPV is positive so project can be accepted at a WACC of 10%.

NPV (@20%) = -2 + 13.5/(1+20%) -11/(1+20%)^2 = 1.61 million

NPV is again positive so project can be accepted at a WACC of 20%.

c). Other projects where clean-ups are required at the end of the project would be having multiple IRRs due to cash outflow at the end such as decommissioning of nuclear power plants, oil drilling projects, etc.

d). MIRR (for WACC of 10%) = 15.71% (calculated using MIRR function in excel)

e). MIRR (for WACC of 20%) = 29.64% (calculated using MIRR function in excel)

MIRR leads to the same accept/reject decision as the NPV since both MIRRs are higher than the respective WACCs.

No, the MIRR method will not always lead to the same decision as the NPV. If mutually exclusive projects which cross over are considered, MIRR method recommendation will differ from the NPV method recommendation.