The Ulmer Uranium Company is deciding whether or not it should open a

QUESTION

The Ulmer Uranium Company is deciding whether or not it should open a strip mine, the net cost of which is $4.4 million. Net cash inflows are expected to be $27.7 million, all coming at the end of Year 1. The land must be returned to its natural state at a cost of $25 million, payable at the end of Year 2.a. Plot the projects NPV profile.b. Should the project be accepted if r = 8%? If r = 14%? Explain your reasoning.c. Can you think of some other capital budgeting situations where negative cash flows during or at the end of the projects life might lead to multiple IRRs?d. What is the projects MIRR at r = 8%? At r = 14%? Does the MIRR method lead to the same accept/reject decision as the NPV method?
Solution: Part a: Multiple Rates of Return COC 8% Initial Cost Cash Flows Time 0 1 2 Project $ (4.40) $28 -$25 PV $4 NPV -$0.19 IRR 9% Cost of Capital NPV IRR -$0.19 9% 2% -$1.27 4% -$0.88 6% -$0.52 8% -$0.19 10% $0.12 12% $0.40 14% $0.66 16% $0.90 18% $1.12 20% $1.32 100% $3.20 200% $2 400% $ 0.14 Part b: If in case the cost of capital which is the discount rate is 8% then reject the project because NPV is negative. But if r = 14%, then accept the project because the NPV is greatert than zero. Part c: Another example for a project which can have multiple rates of returns can be a nuclear power plant as the disposal of radioactive waste is mandatory during the end of the project or at the end of the leavered lease. According to which the amount borrowed will be repaid at the end of the lease period. Part d: r MIRR TV inflow 8% 7.61% PV¦

st -25833470.51 29916000 14% 15.58% PV cost -23636688.21 31578000 From the above calculation, it is clear that by using 14% rate the total inflow is greater than 8% rate and the present value of cost is higher for 8% when comapred to 14%. The fact is that MIRR leads to the same conclusion of NPV, that is to reject the project with r=8% which is actually greater than the computed MIRR 7.61%. But in case of r= 14%, the MIRR is greater and at 15.58% which indicates that the project should be accepted only if r=14%. Thus, both NPV and MIRR leads to same conclusion.

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