4. Modified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the projects IRR. Consider the following situation: Fuzzy Button Clothing Company is analyzing a project that requires an initial investment of $3,225,000. The projects expected cash flows are:

Year Cash Flow

Year 1 $375,000

Year 2 175,000

Year 3 425,000

Year 4 450,000

Fuzzy Button Clothing Companys WACC is 8%, and the project has the same risk as the firms average project.

Calculate this projects modified internal rate of return (MIRR):

a. 17.33%

b. 14.85%

c. -20.01%

d. 18.15%

Fill in the blank

If Fuzzy Button Clothing Companys managers select projects based on the MIRR criterion, they should _____ this independent project.

Which of the following statements about the relationship between the IRR and the MIRR is correct?

a. A typical firms IRR will be greater than its MIRR.

b. A typical firms IRR will be equal to its MIRR.

c. A typical firms IRR will be less than its MIRR.