Question

IBM is evaluating a project in Eutopia. The project will create the following cash flows:

Year	$
0	-1,330,000
1	250,000
2	470,000
3	450,000
4	215,000
5	95,000

All cash flows will occur in Eutopia and are expressed in dollars. In an attempt to improve its economy, the Eutopia’s government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 3.5 percent. If Anderson uses a required return of 12 percent on this project, what are the NPV and IRR of the project? Is the IRR you calculated the MIRR of the project? Why or why not?

Please show all steps for credit.

Answer 1

Calculation of NPV:

			(a)		{b)	{c) = (a)*(b)
Year	Nominal Cash Flow	Working for Effective Cash Flow	Effective Cash Flow	DF Working	Discounting Factor @ 12%	Present Value
0	(1,330,000)	(1,330,000)	(1,330,000)	1	1	(1,330,000.00)
1	250,000	-	-	1/1.12^1	0.892857143	-
2	470,000	250,000*1.035	258,750	1/1.12^2	0.797193878	206,273.92
3	450,000	470,000*1.035	486,450	1/1.12^3	0.711780248	346,245.50
4	215,000	450,000*1.035	465,750	1/1.12^4	0.635518078	295,992.55
5	95,000	215,000*1.035	222,525	1/1.12^5	0.567426856	126,266.66
6	-	95,000*1.035	98,325	1/1.12^6	0.506631121	49,814.50
					NPV:	(305,406.87)

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Calculation of IRR:

At IRR,
Present Value of Cash Outflow = Present Value of Cash Inflow

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IRR of Project :

1,330,000 = 0/(1+IRR)^1 + 258,750/(1+IRR)^2 + 486,450/(1+IRR)^3 + 465,750/(1+IRR)^4 + 222,525/(1+IRR)^5 + 98,325/(1+IRR)^6

Computing for IRR ,

We get IRR = 4%

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Therefore, IRR of Project is 4%

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Q)Is the IRR you calculated the MIRR of the project?

Ans)No, IRR calculated above is not MIRR of the project.

Reason:

IRR assumes that funds from the project reinvest at the project’s rate of return. MIRR assumes that funds from the project reinvest at the firm’s cost of capital (which is often different from the rate of return of a proposed project).