Domenico Raoelli Corporation (DRC) is considering a project where they would ope

Question

Domenico Raoelli Corporation (DRC) is considering a project where they would open a new facility in Seattle, Washington. The DRC’s Project Manager, Mrs. Laura Paoli, has assembled the following information regarding the proposed project:

• It would cost $500,000 today (at t = 0) to construct the new facility. The cost of the facility will be depreciated on a straight-line basis over five years.
• If DRC opens the facility, it will need to increase its inventory by $100,000 at t = 0. $70,000 of this inventory will be financed with accounts payable.
• The Project Manager has estimated that the project will generate the following amount of revenue over the next three years:

Year 1 Revenue = $1.0 million
Year 2 Revenue = $1.2 million
Year 3 Revenue = $1.5 million

• Operating costs excluding depreciation equal 70% of revenue.
• DRC plans to abandon the facility after three years. At t = 3, the project’s estimated salvage value will be $200,000. At t = 3, DRC will also recover the net operating working capital investment that it made at t = 0.
• The project’s cost of capital is 14%.
• The DRC’s tax rate is 40%.

What is the project’s modified internal rate of return (MIRR)?

Explanation / Answer

      MIRR      = nth root of(FV of postive cashflows , cost of capital)/PV(Initial cost , financing outlya)        Calculation of Cash flows:
Revenue Operating costs(OC) Depreciation EBIT = Revenue - OC Taxes 40% Net income Cash flows= Dep + Net income 1 $1,000,000 $700,000 $100,000 $300,000 $120,000.0 $180,000.0 $280,000.0 2 $1,200,000 $840,000 $100,000 $360,000 $144,000.0 $216,000.0 $316,000.0 3 $1,500,000 $1,050,000 $100,000 $450,000 $180,000.0 $270,000.0 $370,000.0 At the end of the third year the project estimanted salvage value is $200,000. This is an flow for the third year.    Year               Cash flows       1                    $280,000       2                    $316,000       3                    $370,000 + 200,000 = $570,000 Calculation of Cash flows: Revenue Operating costs(OC) Depreciation EBIT = Revenue - OC Taxes 40% Net income Cash flows= Dep + Net income 1 $1,000,000 $700,000 $100,000 $300,000 $120,000.0 $180,000.0 $280,000.0 2 $1,200,000 $840,000 $100,000 $360,000 $144,000.0 $216,000.0 $316,000.0 3 $1,500,000 $1,050,000 $100,000 $450,000 $180,000.0 $270,000.0 $370,000.0 At the end of the third year the project estimanted salvage value is $200,000. This is an flow for the third year.    Year               Cash flows       1                    $280,000       2                    $316,000       3                    $370,000 + 200,000 = $570,000 Calculation of initial cost:                   = Cost + Inventory cost                   = $500,000 + ($100,000 - 70,000)                   = $530,000                   = Cost + Inventory cost                   = $500,000 + ($100,000 - 70,000)                   = $530,000 FV of postitive cash flows at t=3, cost of capital 14%,                   = 280,000(1+14%)^2 + 316000(1+14%)^1+570000(1+14%)^0                   = 280000*1.14 + 316000*1.14 + 570000                   =319200 + 360240 + 570000                   = 1,249,440       MIRR      = Cube root of (1249440/530000)                      = 1.3309 -1                      = 0.3309    MIRR is 33.09%                      = 1.3309 -1                      = 0.3309    MIRR is 33.09% Revenue Operating costs(OC) Depreciation EBIT = Revenue - OC Taxes 40% Net income Cash flows= Dep + Net income 1 $1,000,000 $700,000 $100,000 $300,000 $120,000.0 $180,000.0 $280,000.0 2 $1,200,000 $840,000 $100,000 $360,000 $144,000.0 $216,000.0 $316,000.0 3 $1,500,000 $1,050,000 $100,000 $450,000 $180,000.0 $270,000.0 $370,000.0

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