Activity 19 Capital Budgeting: IRR, MIRR, PI The purpose of this assignment is t

Question

Activity 19 Capital Budgeting: IRR, MIRR, PI The purpose of this assignment is to practice capital budgeting via IRR, MIRR, PI and cross-over rate Group Number Class meeting Morning / Afternoon You are (again) asked to evaluate a new tractor project for Deere. The engineers and marketing and accounting folks have pooled their efforts to generate the following expectations about the project's cash flows (FCFF). The WACC = 10%. t-01 9 10 CF 30 40 50 40 50 50 30 30 20 10 -200 What is the IRR of the project? What is the profitability index (PI) of the project? What is the project's MIRR? a) Do it "brute force" by compounding each cash inflow individually (to the end of the time line) and then summing these to construct TV. b) Devise a shortcut to calculate the TV, and then continue with the usual steps to calculate MIRR.

Explanation / Answer

For convenient, use excel function IRR, MIRR, and NPV.

Part 1:

IRR = 13.25%, MIRR = 9.65%

Profitability Index = NPV / |C0| + 1 = 26.21/200 + 1 = 1.13

Payback Period = 4 + 40/50 = 4.80 years

Consider investment and financing rates are 10% (WACC)

PV of cash flows from 1 to 10 at (t = 0) = 226.21

FV of cash flows from 1 to 10 at (t = 10) = 586.75

200*(1 + MIRR)^10 = 586.75

MIRR = (586.75/200)^(1/10) – 1 = 0.11363356 = 11.36%

Part 2:

IRR = 7.10%, MIRR = 7.06%

Payback Period = 7 + 60/130 = 7.46 years

Crossover rate is the rate at which NPV is equal for both sets of cash flows.

Or, it is the IRR of cash flows which are difference of cash flows.

Crossover rate = 5.06%

NPV < 0 because investment is higher than cash generated at discounted basis. When PV of investment is higher, MIRR is lower.

0 1 2 3 4 5 6 7 8 9 10 IRR MIRR NPV @ 10% A -200 30 40 50 40 50 50 30 30 20 10 13.25% 11.36% 26.21 B -500 -130 40 80 105 110 115 120 130 130 135 7.10% 8.27% -90.68 B - A -300 -160 0 30 65 60 65 90 100 110 125 5.06% Commulative A -200 -170 -130 -80 -40 10 60 90 120 140 150 Commulative B -500 -630 -590 -510 -405 -295 -180 -60 70 200 335

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