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Hi, for sample answer part (b), it explains that IRR assumes that positive cash flows are reinvested and earn a return at the same rate as the project’s IRR. Does this mean that the positive cash flows are reinvested at 25.6%, which is equivalent to the project’s IRR (calculated in part (b))?
The MIRR assumes that positive cash flows are reinvested at the cost of capital. Does this mean that the positive cash flows are reinvested at 13%, equivalent to the WACC calculated in part (a)?
And then, the assumption of the MIRR is more reasonable, because the 13% is the actual cost of capital, and it is consistent with the NPV as have been calculated as $1,490,000 (for 13% discount factor) and $663,000 (for 20% discount factor)? Whilst, IRR is not so reasonable because the discount factor is at 25.6%, and IRR will set NPV equal to zero?
Please may I know whether I am wrong in any of these interpretation? Thank you.
You are correct. However as I explain in my lectures on this, it is all a little bit silly. Using the IRR is only a potential problem when choosing between investments. The MIRR is a sort of cheat way of making sure that we choose the best one. (But since we always choose based on the NPV anyway, there isn’t really a need for the MIRR except as an exercise in the exam when asked for)
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