CA INTER FM, Modigilani MM Approach |Dividend Decisions| FM CA INTER | Practical Question | REVISION
If project has positive NPV it should be accepted with an objective of maximization of wealth of shareholders. However, there may be a situation due to resource (capital) constraints (rationing) a firm may have to select some projects among various projects, all having positive NPVs. Broadly two scenarios may influence the method of evaluation to be adopted.
(i) Rupee of Capital method.
(ii) If projects are not divisible: In such situation projects shall be ranked on the basis of absolute NPV and should be If projects are independent of each other and are divisible in nature:
In such situation NPV Rule should be modified and accordingly projects should be ranked on the basis of ‘NPV per mixed up to the point available resources are exhausted.
There are several limitations attached with the concept of the conventional Internal Rate of Return. The MIRR addresses some of these deficiencies e.g., it eliminates multiple IRR rates; it addresses the reinvestment rate issue and produces results which are consistent with the Net Present Value method. This method is also called Terminal Value method.
Modified Internal Rate of Return (MIRR)
Under this method, all cash flows, apart from the initial investment, are brought to the terminal value using an appropriate discount rate (usually the Cost of Capital). This results in a single stream of cash inflow in the terminal year. The MIRR is obtained by assuming a single outflow in the zeroth year and the terminal cash inflow as mentioned above.
The discount rate which equates the present value of the terminal cash in flow to the zeroth year out flow is called the MIRR.
The decision criterion of MIRR is same as IRR i.e. you accept an investment if MIRR is larger than required rate of return and reject if it is lower than there quired rate of return
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