Homework SourseSuppose your firm is considering investing in a project with
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 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively.
Use the MIRR decision rule to evaluate this project.
| Time: | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| Cash flow: | –$5,000 | $1,200 | $2,400 | $1,600 | $1,600 | $1,400 | $1,200 |
Solution
Required Return = 8%
Cash Flows:
Year 0 = -$5,000
Year 1 = $1,200
Year 2 = $2,400
Year 3 = $1,600
Year 4 = $1,600
Year 5 = $1,400
Year 6 = $1,200
Future Value of Cash Inflows = $1,200*1.08^5 + $2,400*1.08^4 + $1,600*1.08^3 + $1,600*1.08^2 + $1,400*1.08 + $1,200
Future Value of Cash Inflows = $11,622.1464
MIRR = (Future Value of Cash Inflows / Present Value of Cash Outflow)^(1/n) - 1
MIRR = ($11,622.1464 / $5,000)^(1/6) - 1
MIRR = 2.32443^(1/6) - 1
MIRR = 1.1509 - 1
MIRR = 0.1509
MIRR = 15.09%
MIRR of this project is 15.09% which is higher than required rate of return. So, the company should accept this project.
