The IRR evaluation method assumes that cash flows from theproject are reinvested at the same rate equal to the IRR. However,in reality the reinvested cash flows may not necessarily generate areturn equal to the IRR. Thus, the modified IRR approach makes amore reasonable assumption other than the project’s IRR.

Consider the following situation:

Blue Llama Mining Company is analyzing a project that requiresan initial investment of $550,000. The project’s expected cashflows are:

Year	Cash Flow
Year 1	$275,000
Year 2	–175,000
Year 3	400,000
Year 4	425,000

Blue Llama Mining Company’s WACC is 8%, and the project has thesame risk as the firm’s average project. Calculate this project’smodified internal rate of return (MIRR):

1.) 14.51%

2.) 12.33%

3.) 13.78%

4.) 11.61%

If Blue Llama Mining Company’s managers select projects based onthe MIRR criterion, they should __________ this independentproject.

Which of the following statements best describes the differencebetween the IRR method and the MIRR method?

1.) The IRR method uses only cash inflows to calculate the IRR.The MIRR method uses both cash inflows and cash outflows tocalculate the MIRR.

2.) The IRR method uses the present value of the initialinvestment to calculate the IRR. The MIRR method uses the terminalvalue of the initial investment to calculate the MIRR.

3.) The IRR method assumes that cash flows are reinvested at arate of return equal to the IRR. The MIRR method assumes that cashflows are reinvested at a rate of return equal to the cost ofcapital.