Problem 12-21 Modified internal rate of return [LO4] The Caffeine Coffee Company
ID: 2744758 • Letter: P
Question
Problem 12-21 Modified internal rate of return [LO4]
The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 13 percent. The project being analyzed is as follows ($32,000 investment): Calculate your final answer using the formula and financial calculator methods.
Year
Cash Flow
1
$
15,000
2
12,000
3
10,000
a.
What is the modified internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
Internal rate of return
%
The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 13 percent. The project being analyzed is as follows ($32,000 investment): Calculate your final answer using the formula and financial calculator methods.
Explanation / Answer
modified internal rate of return:
year
Cash flows
Working
FV Factor
Terminal Value
0
(32,000)
-
1
15,000
=(1+13%)^(3-1)
1.27690
19,153.50
2
12,000
=(1+13%)^(3-2)
1.13000
13,560.00
3
10,000
=(1+13%)^(3-3)
1.00000
10,000.00
Terminal Value
42,713.50
Modified Internal Rate of Return
= n Terminal Value of Cash Inflows/ Present Value of Cash Outflows-1
= 3 42,713.50/32,000-1
= 3 42,713.50/32,000-1
= 3 1.334797 -1
=1.334797 1/3-1
=1.101044978-1
=0.101044978 or 10.10%
internal rate of return:
year
Cash flows
0
(32,000)
1
15,000
2
12,000
3
10,000
IRR
8.21%
Alternatively we can use trial and error method let us try with 8%
year
Cash flows
PV Factor
PV
0
(32,000)
1.0000
(32,000.00)
1
15,000
0.9259
13,888.89
2
12,000
0.8573
10,288.07
3
10,000
0.7938
7,938.32
NPV
115.28
As NPV is positive let us try with 9%
year
Cash flows
PV Factor
PV
0
(32,000)
1.0000
(32,000.00)
1
15,000
0.9174
13,761.47
2
12,000
0.8417
10,100.16
3
10,000
0.7722
7,721.83
NPV
(416.54)
IRR= R1+(NPV1(R2-R1)%/(NPV1-NPV2)
=8% + 115.28 (9-8)%/(115.28-(416.54)
=8% +1.1528 /531.81
=8% +0.21%
=8.21%
Here both modified internal rate of return and Internal rate of return been asked both answered
year
Cash flows
Working
FV Factor
Terminal Value
0
(32,000)
-
1
15,000
=(1+13%)^(3-1)
1.27690
19,153.50
2
12,000
=(1+13%)^(3-2)
1.13000
13,560.00
3
10,000
=(1+13%)^(3-3)
1.00000
10,000.00
Terminal Value
42,713.50