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Your firm is considering a project that will cost $ 4.548 million up​ front, generate cash flows of $ 3.50 million per year for 3 ​years, and then have a cleanup and shutdown cost of $ 6.00 million in the fourth year.



a. How many IRRs does this project​have?



b. Given a cost of capital of 10.0 % should this project be​ accepted?

Respuesta :

Answer:

(a) It will have multiple IRRs

(b) The MIRR calculated is 10.18% . Going by MIRR result , this project will only generate returns that is equal to cost of capital(10%)  .If there are other avaible more viable projects, it should be rejected ( Please see attached computation).

Explanation:

(a) The multiple IRRs occurs when cash flows change sign and result in more than one value for the IRR.

Application of IRR to value an investment is only suitable when the project has normal cash flows, i.e a negative initial cash flow (i.e initial investment) followed by a series of positive cash flows.

In this scenario, we have negative cash flow of $6m  in year 4 which occured after positive cash flow of $3.5m per year from year 1 to 3. This typically make IRR unreliable. To overcome this limitation , we can use Modified Internal Rate of Return (MIRR)

(b) Please see attached for more details.

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