International Transport Company is considering building a new facility in Seattle. If the company goes ahead with the project, it will spend $2 million immediately
(at t = 0) and another $2 million at the end of Year 1 (t = 1). It will then receive net cash flows of $1 million at the end of Years 2 - 5, and it expects to sell the property for $2 million at the end of Year 6. The company's cost of capital is 12 percent, and it uses the modified IRR criterion for capital budgeting decisions.
Which of the following statements is most correct?
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A. B. C. D. E.Explanation
PV(Outflows) = -$2,000,000 - $2,000,000/1.12 = -$3,785,714.
TV(Inflows) = $1,000,000(FVIFA(12%,4))(1.12) + $2,000,000
= $1,000,000(4.7793)(1.12) + $2,000,000 = $7,352,816.
1 + MIRR = [7,352,816/3,785,714]^1/6; MIRR = 11.7%.
Since the MIRR is less than the cost of capital, the IRR is less than the MIRR.