FM11 37 - exclusive projects are involved. g. 1. Define the...

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What projects will be accepted, by either NPV or IRR? Projects A, B, C, and D. If the same situation exists year after year, at what rate of return will cash flows from earlier years' investments be reinvested? Capital budgeting decisions are made in this sequence: (1) the company would say, "we can take on A, B, C, and D and finance them with 10% money, so let's do it." (2) then, it would get cash flows from earlier years' projects. What would it do with those cash flows? It would use them in lieu of raising money that costs 10%, so it would save 10%. Therefore, 10% is the opportunity cost of the cash flows. In effect, cash flows are reinvested at the 10% cost of capital . Note, however, that NPV and IRR always give the same accept/reject decisions for independent projects, so IRR can be used just as well as NPV when independent projects are being evaluated. The NPV versus IRR conflict arises only if mutually
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Unformatted text preview: exclusive projects are involved. g. 1. Define the term Modified IRR (MIRR). Find the MIRRs for franchises L and S. Answer: MIRR is that discount rate which equates the present value of the terminal value of the inflows, compounded at the cost of capital, to the present value of the costs . Here is the setup for calculating franchise L's modified IRR: 0 1 2 3 | | | | PV Of Costs = (100.00) 10 60 80.00 66.00 12.10 r = 10% TV OF INFLOWS = 158.10 MIRR = ? PV Of TV = 100.00 = $100 = 3 ) MIRR 1 ( 10 . 158 $ + . PV costs = n ) MIRR 1 ( TV + = ∑ = + n t t t ) r 1 ( COF = n n 1 t t n t ) MIRR 1 ( ) r 1 ( CIF + + ∑ = − . After you calculate the TV, enter n = 3, PV = -100, pmt = 0, fv = 158.1, and then press i to get the answer, MIRR L = 16.5%. We could calculate MIRR S similarly: = 16.9%. Thus, franchise S is ranked higher than L. This result is consistent with the NPV decision. Mini Case: 11 - 37...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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