Question

1. Which provides a better estimate of a project’s “true” rate of return, the MIRR or the regular IRR? Explain.

2. Project X is very risky and has an NPV of $3 million. Project Y is very safe and has an NPV of $2.5 million. They are mutually exclusive, and project risk has been properly considered in the NPV analyses.

Which project should be chosen? Explain.

Answer 1

1.Internal rate of return is the rate of return that makes the net present value of all cash flows of a certain investment equal to zero. It is helpful in comparing investments and making capital budgeting decisions.

Modified internal rate of return is a modification of internal rate of return (IRR). It works on the premise that all project cash flows are discounted at the cost of capital and they are reinvested at the reinvestment rate.

Since cash flows in MIRR are reinvested at the cost of capital, it eliminates a drawback of IRR where cash flows are reinvested at the internal rate of return. So, the MIRR is a better indicator of a project’s true profitability.

2.Project X is chosen according to the decision rule of NPV since the net present value is higher.

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