CFIN
CFIN
6th Edition
ISBN: 9780357144039
Author: BESLEY
Publisher: CENGAGE L
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Chapter 9, Problem 15PROB
Summary Introduction

Net present value:

Net present value is the difference between the present values of cash inflows minus present value of cash outflows.

Calculate the cost of retained earnings are as follows:

Net present value=Present value of cash inflowsInitial investment

Decision rule:

NPV>0 Accept the projectNPV<0 Reject the project

IRR:

IRR is also called as internal rate of return. That is the rate at which present value of cash inflows will be equal to present value of cash outflows. At IRR, NPV will be equal 0.

Decision for IRR rule:

IRR>Cost of capital,  Accept the projectIRR<Cost of capital, Reject the project

MIRR:

MIRR is also called as modified internal rate of return. Under MIRR cash flows are reinvested at cost of capital. IRR assumes cash flows are reinvested at IRR, which is unrealistic, this was mitigated by the MIRR.

Calculate the MIRR as follows:

MIRR=Future value of cash flowsPresent value of cash flowsn1

Decision for MIRR rule:

MIRR>Cost of capital,  Accept the projectMIRR<Cost of capital, Reject the project

Cost of the project is $365,000 and cash inflows are $260,000 in year 1 and $175,000 in year 2. Cost of capital is 13%.

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