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: Celestial Crane Cosmetics is analyzing a project that requires an initial investment of $500,000. The project's expected cash flows are: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $300,000 -175,000 475,000 400,000 Celestial Crane Cosmetics'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): 18.71% 0 14.97% 15.90% 22.45% If Celestial Crane Cosmetics's managers select projects based on the MIRR criterion, they should independent project.

Answer 1

B8 Foc -MIRR(B3:37,0.08,0.08) D E F G H I J K 1 Project w 2 year Cash flows 0 $ (5,00,000.00) 1 $ 3,00,000.00 2 $ (1,75,000.00) 3 $ 4,75,000.00 4 $ 4,00,000.00 | 18.71% 10 11 Accept the Project 12 13 IRR method assumes that the rate at which cash flows can be reinvested at the Internal rate of return 14 MIRR calculation implicitly assumes that intermediate cash flows are reinvested at the rate of return equal to the cost of capital 15 16