FM11_Ch_10_Tool_Kit

# The terminal value is defined as the sum of the

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Unformatted text preview: e values of the 'project's cash inflows, compounded at the project's cost of capital. To find MIRR, calculate the PV of the outflows 'and the FV of the inflows, and then find the rate that equates the two. Or, you can solve using the MIRR function. WACC = MIRRS = MIRRL = 10% Project S 10% 0 (1,000) 1 500 2 4 00 3 300 12.11% 11.33% 0 (1,000) PV: 1 100 2 300 B300 4 6 00 4 4 0.0 363.0 133.1 Terminal Value: 1,536.1 (1,000) 3 4 00 The advantage of using the MIRR, relative to the IRR, is that the MIRR assumes that cash flows received are reinvested at the cost of capital, not the IRR. Since reinvestment at the cost of capital is more likely, the MIRR is a 'better indicator of a project's profitability. Moreover, it solves the multiple IRR problem, as a set of cash flows can have but one MIRR . Note that if negative cash flows occur in years beyond Year 1, those cash flows would be discounted at the cost of capital and added to the Year 0 cost to find the total PV of costs. If both positive and negative flows occurred in some year, the negative flow should be discounted, and the positive one compounded, rather than just dealing with the net cash flow. This makes a difference. Also note that Excel's MIRR function allows for discounting and reinvestment to occur at different rates. Generally, MIRR is defined as reinvestment at the WACC, though Excel allows the calculation of a special MIRR where reinvestment occurs at a different rate than WACC. Finally, it is stated in the text, when the IRR versus the NPV is discussed, that the NPV is superior because (1) the NPV assumes that cash flows are reinvested at the cost of capital whereas the IRR assumes reinvestment at the IRR, and (2) it is more likely, in a competitive world, that the actual reinvestment rate is more likely to be the cost of capital than the IRR, especially if the IRR is quite high. The MIRR setup can be used to prove that NPV indeed does assume reinvestment at the WACC, and IRR at the IRR. P roject S WACC = 10% 0 (1,000) P V outflows P V of TV NPV 1 500 2 4...
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