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A project that I am working on has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years
A project that I am working on has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years. The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. I calculated a cost of capital for the firm of 12 percent. What is the project's MIRR?
Expert Solution
While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm's cost of capital. Therefore, MIRR more accurately reflects the profitability of a project. Also we will compare it with our cost of capital. To calculate MIRR, all the cash inflows are compounded to the terminal year, in this case Year 8, at the project's cost of capital, and then these compounded values are summed to produce the project's terminal value. Then, MIRR is found as the discount rate that causes the present value of the terminal value to equal the net cost of the equipment.
References:
1. Financial Management by I.M. Pandey
2. www.investopedia.com
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