Aa Aa 4. Modified internal rate of return (MIRR) The IRR evaluation method assum

Question

Aa Aa 4. Modified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project's IRR. Consider the following situation: Blue Llama Mining Company is analyzing a project that requires an initial investment of $450,000. The project's expected cash flows are: Year 1 $325,000 Year 2 -125,000 Year 3 450,000 Year 4 450,000 Blue Llama Mining Company's WACC is 8%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR):

Explanation / Answer

Question 1). Answer :- Option B). 28.36 % (approx).

Explanation :- Calculation of Modified internal rate of return (MIRR) in the given question :-

Modified internal rate of return (MIRR) = (1199606.40 / 450000)1/4 - 1

= (2.665792)0.25 - 1

= 1.28 (approx) - 1

= 0.28 i.e., 28 % (Most nearest to the 28.36 % mentioned in option B to the above given question)

Conclusion :- Modified internal rate of return (MIRR) = 28.36 % (Option B).

Question 2). Answer :- Blue Liama Mining Company should accept the project.

Question 3). Answer :- Option B). 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.

Year Cash flow Future value factor Terminal value of cash flow 1 325000 (1.08)4 - 1 = 1.259712 409406.40 (325000 * 1.259712) 2 (-) 125000 (1.08)4 - 2 = 1.1664 (-) 145800.00 (125000 * 1.166400) 3 450000 (1.08)4 - 3 = 1.08 486000.00 (450000 * 1.08) 4 450000 (1.08)4 - 4 = 1 450000.00 (450000 * 1.00) Total 1199606.40

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