Suppose your firm is considering investing in a project with the cash flows show
ID: 2723710 • Letter: S
Question
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 2.5 years, respectively. Time 0 1 2 3 4 5 Cash Flow -125,000 65,000 78,000 105,000 105,000 25,000 use the MIRR decision rule to evaluate this project; should it be accepted or rejected? a. 12% reject b. 31.21% accept c. 54.22% accept d. 80.67% accept
Explanation / Answer
The present value of cash flows at the beginning at 12% discount rate are as follows:
Year
Cash Flow ($)
PV ($)
1
65000
58035.71
2
78000
62181.12
3
105000
74736.93
4
105000
66729.4
5
25000
14185.67
Total
378000
275868.8
Initial outlay = $ 125000
Payback period = 5/ (378000/ 125000) = 1.65 years
Discounted payback period = 5 / (275868.8 / 125000) = 2.27 years
Since maximum allowable payback period and discounted payback period are 2 years and 2.5 years respectively, both are acceptable.
The future value of positive cash flows at 12% discount rate = 275868.8 x 1.125 = $ 486175.1
Modified internal rate of return MIRR = (486175.1 / 125000)1/5 - 1 = 0.3121
Therefore, MIRR is 31.21% which greater than expected rate of return i.e. 12%.
Hence, accept the project at 31.21%.
Year
Cash Flow ($)
PV ($)
1
65000
58035.71
2
78000
62181.12
3
105000
74736.93
4
105000
66729.4
5
25000
14185.67
Total
378000
275868.8
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