The Caffeine Coffee Company uses the modified internal rate of return. The firm
ID: 2691535 • Letter: T
Question
The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 12 percent. The project being analyzed is as follows ($27,000 investment): Year Cash Flow 1 .................... $15,000 2 .................... 12,000 3 .................... 9,000 What is the modified internal rate of return? An approximation from Appendix B is adequate for the final answer. (You do not need to interpolate.) Assume the traditional internal rate of return on the investment is 17.5 percent. Explain why your answer in part a would be lower.Explanation / Answer
First we find the future value of the cash flows. 15,000 (1.12)^2 + 12,000(1.12) + 9,000= 41,256 Now we divide by the present value of the investment 41,256/27,000= 1.528 Now we find the geometric return (1.528)^(1/3) -1= 1.1518-1= 15.18%. This answer would be lower than the 17.5 because it assumes that the cash flows are invested at the cost of capital rather than at the internal rate of return of the project.