question archive Durango Cereal Company is considering adding two new kinds of cereal to its product line—one geared toward children and the other toward adults
Durango Cereal Company is considering adding two new kinds of cereal to its product line—one geared toward children and the other toward adults
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Durango Cereal Company is considering adding two new kinds of cereal to its product line—one geared toward children and the other toward adults. The company is currently at full capacity and will have to invest a large sum in machinery and production space. However, given the nature of cereal production, the investment in machinery will be more costly for the children's cereal (Poofy Puffs) than for the adult cereal (Filling Fiber). The expected cash flows for the two cereals are:
Year Poofy Puffs Filling Fiber
0 −$24,890,000 −$13,500,000
1 12,950,000 7,230,000
2 10,923,000 8,100,000
3 8,231,000 8,629,000
4 7,242,000 5,238,900
Management requires a minimum return of 15% in order for the project to be acceptable. The discount rate for projects of this level of risk is 10%. Management requires projects with this type of risk to have a minimum payback of 1.75 years.
What is the modified internal rate of return?
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Modified Internal rate of return are :
- Poofy Puffs = 17.07%
- Filling Fiber = 26.12%
Step-by-step explanation
Modified Internal rate of return = (Future Value of cash Inflows / Present Value of cash Outflows) ^ (1/N) - 1
Future value of cash inflows = sum of Future value of cash flows at year 4
Future value of cash inflows = ?∑? Cash flows * (1+r)^(N-n)
where, r = 10%, N = 4 years and n is the year of cash flow
Poofy Puffs
- Future Value of cash Inflows = 12950000 * (1+10%)^3 + 10923000 * (1+10%)^2 + 8231000*(1+10%)^ 1 + 7242000 = 46749380
- Present Value of cash Outflows = 24890000
Modified Internal rate of return = (46749380 / 24890000) ^ (1/4) - 1
Modified Internal rate of return = 17.07%
Filling Fiber
- Future Value of cash Inflows = 7230000 * (1+10%)^3 + 8100000 * (1+10%)^2 + 8629000*(1+10%)^ 1 + 5238900 = 34154930
- Present Value of cash Outflows = 13500000
Modified Internal rate of return = (34154930 / 13500000) ^ (1/4) - 1
Modified Internal rate of return = 26.12%
