Fuzzy Button Clothing Company is analyzing a project that requires an initial in

Question

Fuzzy Button Clothing Company is analyzing a project that requires an initial investment of $1,100,000. The project’s expected cash flows are:

1. Fuzzy Button’s WACC is 9.00%, and the project has the same risk as the firm’s average project. The project’s modified internal rate of return (MIRR) is _____ .

2. If Fuzzy Button's managers select projects based on the MIRR criterion, they should accept or reject this independent project.

3. Which of the following statements best describes the difference between the IRR method and the MIRR method?

a.) The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

b.) The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR.

c.) The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR.

How do I solve this?

Year Cash Flow Year 1 $300,000 Year 2 -150,000 Year 3 500,000 Year 4 475,000

Explanation / Answer

1)

year Cash flow PV of -ve cashflows PV of +ve cashflows

0 (1100000) (1100000)

1 300000 275100

2 (150000) (126300)

3 500000 386000

4 475000 336300

Total 1226300 997400

MIRR = [(PV of positive cash flows, reinvestment rate) / (PV of negative cash flows, finance rate) ] ^ n - 1

= (997400 / 1226300)^4 - 1

=-5.03 %

2. If Fuzzy Button's managers select projects based on the MIRR criterion, they should reject this independent project

3. The following statements best describes the difference between the IRR method and the MIRR method

a.) The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

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