Quantitative Problem: Bellinger Industries is considering two projects for inclu
ID: 2764066 • Letter: Q
Question
Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 12%. 0 1 2 3 4 Project A -1,350 650 380 200 250 Project B -1,350 250 315 350 700 What is Project A's MIRR? Round your answer to two decimal places. Do not round your intermediate calculations. % What is Project B's MIRR? Round your answer to two decimal places. Do not round your intermediate calculations. % If the projects were independent, which project(s) would be accepted according to the MIRR method? If the projects were mutually exclusive, which project(s) would be accepted according to the MIRR method?
Explanation / Answer
Formula to calculate MIRR is as below :
MIRR = ( FV of cash flow discounted at WACC/ PV of cash flow discounted at financing cost) ^ 1/N - 1
Project A
Step 1 : calculate FV of cash flow discounted at WACC
FV = ( 650* 1.12^3) + ( 380*1.12^2)+ (200*1.12^1)+250
FV = 913.185 + 476.67+224+ 250
FV= 1863.86
Step 2: present value of cash outflow is 1350
MIRR of project A by applying above formula :
MIRR = ( 1863.86/1350) ^ 1/4 -1
MIRR = (1.38)^ 0.25 - 1
MIRR = 1.084 - 1 = 0.084 = 8.4%
If project is independent, then project A will not be accepted as MIRR is less than the WACC
Project B:
Step 1: calculate FV of cash flow discounted at WACC
FV = ( 250*1.12^3) + ( 315*1.12^2) + (350*1.12^1) + 700
FV = 351.225 + 395.136 +392 + 700
FV = 1838.361
Step 2 : Present value of cash flow of project 2 is 1350
MIRR of project B by applying above formula is
MIRR = (1838.361/ 1350) ^ 1/4 -1
MIRR = (1.362)^0.25 - 1
MIRR = 1.0803 - 1 = 0.0803 = 8.03%
If project is independent then eve project B will not be accepted as MIRR is less than WACC
MIRR may lead to suboptimal decision making when multiple investment options are being considred. As MIRR does not quantify the impact of different investment on wealth of investors in absolute terms . In these senerio NPV provideo more a more effective theoretical basis of selecting the project which has are mutually exlusive. Hence in the given case it is difficult to select option out of two projects when projects are mutually exclusive. As in both the case MIRR is less than WACC. Also MIRR has limitation in selecting out of two mutually exclusive projects.