Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the MIRR on this project? (Round to the nearest percent.)
A) 18%
B) 19%
C) 20%
D) 21%

Question

Quizplus · Accepted Answer

To calculate the MIRR, we need to first calculate the present value of all cash flows at the cost of capital rate of 16%.

PV of cash flows = -$8.5 million + $2 million / (1.16)^1 + $3 million / (1.16)^2 + $4 million / (1.16)^3 + $5 million / (1.16)^4

PV of cash flows = -$8.5 million + $1.724 million + $2.541 million + $2.689 million + $2.668 million

PV of cash flows = $0.123 million

Next, we need to find the terminal value of the project at the end of year four, discount it back to the present value, and calculate the modified internal rate of return using the formula:

MIRR = [(FV of positive cash flows / PV of negative cash flows) ^ (1 / n)] - 1

Where n = the number of periods

Terminal value = $5 million / (0.16 - 0.05) 
Terminal value = $41.67 million

PV of terminal value = $41.67 million / (1.16)^4 
PV of terminal value = $22.29 million

MIRR = [($22.29 million / -$8.5 million) ^ (1 / 4)] - 1 
MIRR = 0.1885 or 18.85%

Therefore, the best choice is B, as it is the closest to the calculated MIRR of 18.85%.