Question

Can you think of some other capital budgeting situations in which negative cash flows during or at the end of the project's life might lead to multiple IRRs? The input in the box below will not be graded, but may be reviewed and considered by your instructor. What is the project's MIRR at r = 10%? Round your answer to two decimal places

Answer 1

Answer:

Multiple IRRs:

Said another way, Multiple IRRs occur when a project has more than one internal rate of return. The problem arises where a project has non-normal cash flow (non-conventional cash flow pattern).

Internal rate of return (IRR) is one of the most commonly used capital budgeting tools. Investors make decisions by comparing the IRR of the project under consideration with the hurdle rate. If the IRR is greater than the hurdle rate, the project is accepted, otherwise it is rejected. When there are more than two IRRs, it is not exactly clear which IRR to compare with the hurdle rate.

Hurdle rate is the minimum required rate of return which businesses use as a benchmark to decide whether to invest in a project or not.

So a typical situation which can generate negative cashflows which can in turn lead to multiple IRRs towards the end of the project is where the conditions of investment become adverse towards the end of the project.

Imagine that toward the end of the lifecycle of a project, a forecasted increase external costs such as Interest Rate, influenced by government policies translates to an erosion of the bottom line generated by the business in that year.

Period                                             0          1       3  3 4 5

Unconventional cash flows ($)-19,000 16,000 16,000 6,000 6,000 -52,000

The series is non-conventional cash-flow pattern, which has two sign changes. This is the range in which the net present value of the non-conventional cash flow series is positive. The multiple IRR problem poses a series problem to analysts because the decision is not obvious.  

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