The Fit & Trim company uses the modified internal rate of return. The firm has a
ID: 2634512 • Letter: T
Question
The Fit & Trim company uses the modified internal rate of return. The firm has a cost of capital of 12 percent. The project being analyzed is as follows ($27,000 investment):
Year
Cash Flow
1............
$15,000
2............
12,000
3............
9,000
a. What is the modified internal rate of return? An approximation from Appendix B is adequate.
b. Assume the traditional internal rate of return on the investment is 17.5 percent. Explain why your answer in part a would be lower.
Year
Cash Flow
1............
$15,000
2............
12,000
3............
9,000
Explanation / Answer
Solution:
a)
Year
CF
Growth period
FV @ 12%
FV
1
$15,000
2
1.254
$18,810
2
$12,000
1
1.120
$13,440
3
$9,000
0
1.000
$9,000
$41,250
MIRR = PV/FV
= $27,000/$41,250
= 0.655
Using appendix B, the answer is 15%.
b) Under MIRR the answer is less than 17% because inflows are reinvested at the cost of capital of 12%. Under traditional IRR, inflows are reinvested at IRR of 17.5% which results in high terminal value.
Year
CF
Growth period
FV @ 12%
FV
1
$15,000
2
1.254
$18,810
2
$12,000
1
1.120
$13,440
3
$9,000
0
1.000
$9,000
$41,250
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