Axis Chemical Co. is analyzing a project that requires an initial investment of
ID: 2652169 • Letter: A
Question
Axis Chemical Co. is analyzing a project that requires an initial investment of $2,225,000. The project’s expected cash flows are:
Year
Cash flow
Year 1
$375,000
Year 2
-150,000
Year 3
475,000
Year 4
425,000
1. Axis Chemical Co.’s WACC is 7%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR):
a. 21.81%
b. 24.53%
c. -12.32%
d. 29.99%
2. If Axis Chemical Co.’s managers select projects based on the MIRR criterion, they should ___________this independent project.
a. reject
b. accept
3. Which oft the following statements about the relationship between IRR and the MIRR is correct?
a. A typical firm’s IRR will be greater than its MIRR.
b. A typical firm’s IRR will be equal to its MIRR.
c. A typical firm’s IRR will be less than its MIRR.
Year
Cash flow
Year 1
$375,000
Year 2
-150,000
Year 3
475,000
Year 4
425,000
Explanation / Answer
Answer:
1
Calculation of MIRR
Year
Cash flow
FVF at WACC 7%
Terminal Value
CF
Calculation
FVF
CF*FVF
Year 1
$ 375,000.00
(1+0.07)^3
1.31080
$ 491,548.50
Year 2
$ (150,000.00)
(1+0.07)^2
1.22504
$ (183,756.45)
Year 3
$ 475,000.00
(1+0.07)^1
1.14490
$ 543,827.50
Year 4
$ 425,000.00
(1+0.07)^0
1.07000
$ 454,750.00
#NUM!
$ 1,306,369.55
$ 2,225,000.00
MIRR = (Terminal Cash flows / initial cash outflows)^n -1
-12.46%
2
MIRR of the Project-12.46 is less than the Required rate of return WACC 7%
Hence the project should be rejected
3
A typical firm’s IRR will be less than its MIRR, Because IRR assumes reinvestment
of intermediary cash flows at IRR, but MIRR assumes it at WACC.
1
Calculation of MIRR
Year
Cash flow
FVF at WACC 7%
Terminal Value
CF
Calculation
FVF
CF*FVF
Year 1
$ 375,000.00
(1+0.07)^3
1.31080
$ 491,548.50
Year 2
$ (150,000.00)
(1+0.07)^2
1.22504
$ (183,756.45)
Year 3
$ 475,000.00
(1+0.07)^1
1.14490
$ 543,827.50
Year 4
$ 425,000.00
(1+0.07)^0
1.07000
$ 454,750.00
#NUM!
$ 1,306,369.55
$ 2,225,000.00
MIRR = (Terminal Cash flows / initial cash outflows)^n -1
-12.46%
2
MIRR of the Project-12.46 is less than the Required rate of return WACC 7%
Hence the project should be rejected
3
A typical firm’s IRR will be less than its MIRR, Because IRR assumes reinvestment
of intermediary cash flows at IRR, but MIRR assumes it at WACC.