Corporate Finance

1) You are evaluating a project that is expected to cost $2.2 million in initial investment and it is expected to generate an end of year cash flow of $1.0 million each year for three years. The discount rate is 11%. What is the MIRR of this investment?

10.89%

The same as the IRR in this case.

17.27%

14.96%

11%

For the MIRR, you have to find the future value of each cash inflow as of the end of year 3:

CF3: the FV is simply $1 million, since you receive it at t=3.

CF2: compound 1 period forward

1 million (1.11) = 1.11 million

CF1: compound 2 periods forward

1 million (1.11)2 = 1.232 million

The sum of these future values is:

1+1.11+1.232 = 3.342

Now find the interest rate that equates the PV of 2.2 with the FV of 3.342:

N: 3

I: ?  14.96%

PV: (2.2)

PMT: 0

FV: 3.342

2) Project Z’s only cash outflow is its cost of $10,000. The project has a NPV of $16,000. What is the profitability index for this project?

1.2

2.6

1.7

1.6

0.6

You first need to find the PV (inflows):

NPV=PV (inflows)- PV (outflows)

16,000=PV (inflows)- 10,000

PV (inflows)=26,000

So:

PI=(PV (inflows))/(PV (outflows))=26,000/10,000=2.6

3) If a project has an IRR that is equal to the discount rate, the NPV for the project is:

Neither here nor there

Either positive or negative

Negative

Zero

Positive

4) The Green Thumb Landscaping Company can purchase equipment on sale for $3200. The asset has a two-year life, and will produce $800 in the first year, and $3000 in the second year. The cost of capital is 15%. Should this project be accepted?

No

Yes

Maybe so

I don’t know

Using either the NPV or the IRR will provide the same decision:

NPV = -235.92

IRR = 10.13%

5) The factors that cause problems with the use of IRR in projects that are mutually exclusive are:

Scale and reversing flow problems

Timing and scale problems

The differential equations problem

The IRR complexity problem and the scale problem