MIRR and Unequal Lives Practice Problems 1) Project M and N have the following p
ID: 2760156 • Letter: M
Question
MIRR and Unequal Lives
Practice Problems
1) Project M and N have the following projected after-tax cash flows. The company’s WACC is 9%.
M N
Cost ($2,000,000) ($2,200,000)
Year 1 500,000 600,000
Year 2 500,000 600,000
Year 3 500,000 600,000
Year 4 500,000 600,000
Year 5 500,000 600,000
a) What is the MIRR of each project? (Note: since the cash inflows are the same in each year, you can use the PMT button to input the flows to create the terminal value for Step 1 of the MIRR calculation.)
b) If the projects are mutually exclusive, what decision should the company make?
c) If the projects are independent, what decision should the company make?
2) A company is considering two project opportunities for a piece of land the company currently owns. One is to open a restaurant and the other is to open a gym. The projects are mutually exclusive. Their after-tax projected cash flows are outlined below. If the company opens a restaurant, it would plan on selling the restaurant after 3 years. If the company opens a gym, it would plan on selling the gym after 6 years. The company has a 12% weighted average cost of capital. What decision should the company make? (Use both replacement chain and equivalent annual annuity approaches to determine the appropriate decision.)
Restaurant Gym
Cost ($1,500,000) ($2,400,000)
Year 1 500,000 400,000
Year 2 750,000 600,000
Year 3 2,000,000 900,000
Year 4 1,000,000
Year 5 1,000,000
Year 6 2,500,000
Explanation / Answer
Anwer to 1 Project M Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash outlflow -2,000,000 Cash Inflow - 500,000 500,000 500,000 500,000 500,000 Cash Inflow -Net -2,000,000 500,000 500,000 500,000 500,000 500,000 Discount rate @ 9% 1.000 0.917 0.842 0.772 0.708 0.650 PV of Cash Inflow -2,000,000 458,716 420,840 386,092 354,213 324,966 Cummulative Cash inflow -2,000,000 -1,541,284 -1,120,444 -734,353 -380,140 -55,174 Possitive value of Cash flow 1,944,826 IRR Project M sqrt ( 1944826/2000000)-1 = -1.39% Project N Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash outlflow -2,200,000 Cash Inflow - 600,000 600,000 600,000 600,000 600,000 Cash Inflow -Net -2,200,000 600,000 600,000 600,000 600,000 600,000 Discount rate @ 9% 1.000 0.917 0.842 0.772 0.708 0.650 PV of Cash Inflow -2,200,000 550,459 505,008 463,310 425,055 389,959 Cummulative Cash inflow -2,200,000 -1,649,541 -1,144,533 -681,223 -256,168 133,791 Possitive value of Cash flow 2,333,791 IRR Project N sqrt ( 2333791/2200000)-1 = 3% B) If both the project are mutaully exclusive, then PVF of the project = $1944826+$2333791 = $ 4278617 IRR of the project sqrt ( 4278617/4200000)-1 = 0.93% The company may accept the both project as it is mutually exclusive and have the positive IRR. C) If both the project are independent, then company should not accept any of the project M, as it has a negative IRR. Answer 2 Restaurant Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Cash outlflow -1,500,000 Cash Inflow - 500,000 750,000 2,000,000 Cash Inflow -Net -1,500,000 500,000 750,000 2,000,000 - - Discount rate @ 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 PV of Cash Inflow -1,500,000 446,429 597,895 1,423,560 - - - Cummulative Cash inflow -1,500,000 -1,053,571 -455,676 967,884 967,884 967,884 967,884 Possitive value of Cash flow 2,467,884 IRR Restaurant sqrt ( 2467884/1500000)-1 = 28.27% GYM Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Cash outlflow -2,400,000 Cash Inflow - 400,000 600,000 900,000 1,000,000 1,000,000 2,500,000 Cash Inflow -Net -2,400,000 400,000 600,000 900,000 1,000,000 1,000,000 2,500,000 Discount rate @ 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 PV of Cash Inflow -2,400,000 357,143 478,316 640,602 635,518 567,427 1,266,578 Cummulative Cash inflow -2,400,000 -2,042,857 -1,564,541 -923,939 -288,421 279,006 1,545,584 Possitive value of Cash flow 2,679,006 IRR GYM sqrt ( 2679006/2400000)-1 = 5.65% Here IRR of resturant business is better than the GYM, it is advisable to invest in Restaurant
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