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2 views

Critical Thinking Question

Uploaded by

nellyadhiambo29
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© © All Rights Reserved
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Critical Thinking Question and Feasibility Analysis

Student’s Name

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Course

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Critical Thinking Question and Feasibility Analysis

Critical Thinking

The Internal Rate of Return (IRR), for instance, is quite popular in the assessment of investment

projects, but the method is not devoid of a number of flaws that render it ineffective under given

circumstances. One drawback is that the model can have multiple IRRs or none. This occurs when the

cash flow moves in multiple directions, from negative to positive and then back to negative, leading to

multiple IRRs or possibly none at all. Consequently, the decision-making process becomes muddled.

The last weakness of the IRR is that it also assumes that all the cash flows in the future periods will be

reinvested at the rate equivalent to the calculated IRR (Kierulff, 2008). This assumption could be wrong,

for example, when the ratio of IRR is much higher than the market rate or the reinvestment rate of the

firm. For instance, if IRR is pointing to 20 percent, then it means all the interim cash flows are being

reinvested at 20 percent, which in most cases is untrue if, for instance, the actual reinvestment

percentage is only 10 percent (Tan, 2017). These limitations can, however, be avoided by using the

Modified Internal Rate of Return (MIRR). The MIRR eliminates all higher cash inflows and reinvests

the remaining funds at a lower rate (10 percent in this case), while also accounting for the cost of capital

used to fund the project. This leads to the determination of a single distinct rate, thereby solving the

problem of multiple IRRs.

The MIRR is calculated using the formula:


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By using MIRR, you get a more realistic measure of the project's profitability, addressing IRR’s

limitations.

Feasibility of the Business Venture

The financial analysis of the business shows strong investment potential. The Net Present Value

(NPV) is $2,562,475.69, indicating the project will add value beyond the initial investment. With an

Internal Rate of Return (IRR) of 23%, significantly higher than the typical 10-15% cost of capital, the

project promises substantial returns. The payback period is just 0.43 years, allowing quick recovery of

the investment. The profitability index (PI) of 3.19 suggests high returns for every dollar invested, and

the discounted payback period of 7.38 years is reasonable (Zhang, 2022). The Modified Internal Rate of

Return (MIRR) is 13%, confirming the project's financial viability.


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References

Kierulff, H. (2008). MIRR: A better measure. Business Horizons, 51(4), 321-

329. https://doi.org/10.1016/j.bushor.2008.02.005

Tan, Q. (2017). Discount rates, internal rate of return and payback periods. Net Present Value and Risk

Modelling for Projects, 41-58. https://doi.org/10.4324/9781315248172-10

Zhang, Y. (2022). Comparison of net present value model and internal rate of return model in

investment decisions. BCP Business & Management, 30, 502-

507. https://doi.org/10.54691/bcpbm.v30i.2494

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