Taylor Technologies has a target capital structure, which is 40 percent debt and 60 percent equity. The equity will be financed with retained earnings. The company's bonds have a yield to maturity of 10 percent. The company's stock has a beta = 1.1. The risk-free rate is 6 percent, the market risk premium is 5 percent, and the tax rate is 30 percent. The company is considering a project with the following cash flows:
TimeCash flow ($)
0-50,000
135,000
243,000
360,000
4-40,000
What is the project's modified internal rate of return (MIRR)?
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A. B. C. D. E.Explanation
First, find the company's weighted average cost of capital:
We're given the before-tax cost of debt, k(d) = 10%. We can find the cost of equity as follows:
K(s) = 0.06 + 0.05(1.1) = 0.115 or 11.5%.
Thus, the WACC is:
k = 0.4(0.10)(1 - 0.3) + 0.6(0.115) = 0.097 or 9.7%.
Second, the PV of all cash outflows can be calculated as follows:
PV of CF(4): N = 4, I = 9.7, PMT = 0, FV = 40,000 and solve for PV. Total PV(Costs) = -$50,000 - $27,620.62 = -$77,620.62.
Third, find the terminal value of the project at t = 4:
FV of CF(1) at t = 4 is calculated as follows: N = 3, I = 9.7, PV = -35,000, PMT = 0, and solve for FV = $46,204,89. Similarly, the FVs of CF(2) and CF(3) are found to be $51,746.59 and $65,820, respectively. Summing these FVs gives a terminal value of $46,204.89 + $51,746.59 + $65,820.00 = $163,771.48.
Finally, the MIRR can be calculated as N = 4, PV = -77,620.62, PMT = 0, FV = 163,771.48, and solve for I = MIRR = 20.52%.