Wyatt and Zachary Enterprises (WZE) uses the Modified Internal Rate of

Wyatt and Zachary Enterprises (WZE) uses the Modified Internal Rate of Return (MIRR) when evaluating projects.

WZE’s cost of capital is 9.75%. What is the MIRR of a project if the initial cost is $1,200,000 and the project will last seven years, with each year producing cash inflows of $290,000? Should WZE accept this project according to the MIRR method? Explain.
What will be an ideal response?

ANSWER

Answer:
Step One. Find the future values of all the cash inflow by reinvesting the cash inflow at the appropriate cost of capital. We can use the future value annuity formula, given that the cash inflow stream is identical. We have: FV = $290,000 × = $290,000 × = $290,000 × 9.414619. Thus, FV = $2,730,240.
Step Two. Find the present value of the cash outflow by discounting at the appropriate cost of capital. This is the initial cash outflow of -$1,200,000 because all investment is made at the start of the project. Expressing the cash outflow in absolute terms: PV= $1,200,000.
Step Three. Find the interest rate that equates the present value of the cash outflow with the future value of the cash inflow given as: MIRR = (FV / PV)n – 1 = ($2,730,240 / $1,200,000)7 – 1 = (2.2751996)7 – 1 = 1.124612 – 1 = 0.124612 or about 12.46%. Since the MIRR is greater than the cost of capital (e.g., 12.46% > 9.75%), WZE should accept the project. To verify this, WZE can compute the NPV; in doing this, they would find out that it is positive, e.g., NPV = $223,537.95.