Intelligent Semiconductor's New Data Storage Medium: MIRR Calculation

MIRR Calculation for Intelligent Semiconductor's New Data Storage Medium

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Question

Intelligent Semiconductor is considering the development of a new data storage medium, which will allow tremendous increases in the efficiency of its customer's high-end server lines. The development of the new system will take place in the firm's existing facilities, and the storage costs for the additional equipment are expected to be residual in nature. The following information applies to this project:

Rent expense for the firm's existing facilities ($10,500)

Initial cash outlay ($50,000)

t1: $15,000

t2: $11,000

t3: $11,000

t4: $15,000

t5 ($10,000)

t6 ($10,000)

t7 $25,000

Discount rate: 9%

Assuming no taxes or related charges, that the initial cash outlay does not include any sunk costs, and a $0.00 salvage value at t7, what is the MIRR of this project?

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A

In this example, you are asked to calculate the Modified Internal Rate of Return for a project. In calculating the MIRR for this project, the rent cost of $10,500 is ignored because this expense represents a sunk cost. Remember that sunk costs are irrelevant in capital budgeting decisions, and should not beincorporated into the calculation. This is due to the fact that sunk costs are not incremental in nature, and are not directly related to the acceptance of the project in question, i.e. these costs have already been incurred or have been earmarked for payment. The following illustration details the calculation of the Terminal Value (TV) for the

MIRR calculation in this case: {[$15,000 *1.6771] + [11,000 * 1.53862] + [11,000 * 1.41158] + [$15,000 * 1.29503] + [$25,000 * 1]}= TV $102,034.15. The calculation of the present value of the cash outflows is found by discounting the cash outflows of periods 5 and 6 and adding them to the initial cash outlay as follows: {-$50,000 + [- $10,000/1.53862] + [-$10,000/1.6771]= PV of cash outflows ($62,462.00). Incorporating these figures into your calculator's cash flow worksheet will yield the MIRR of 7.2623%. The calculation is found by the following: PV=($62,462.00), FV= $102,034.15, PMT=0, N=7, CPT I/Y ---7.2623%. The modified IRR has a significant advantage over the regular IRR, in the fact that MIRR assumes cash flows from all projects are reinvested at some explicit rate, while the regular IRR assumes that all cash flows are reinvested at the project's IRR. This allows for much greater flexibility.

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