Final answer:
To determine the maximum shutdown costs for a project with a 14.8% cost of capital, you must calculate the future value of the cash inflows, compute their present value at year 11, and then ensure it covers the initial investment and meets the cost of capital. The financial analysis can be performed with Excel or a financial calculator. The shutdown costs should not exceed the calculated limit to achieve the desired return on investment.
Step-by-step explanation:
When calculating the maximum shutdown costs of a project using the Modified Internal Rate of Return (MIRR) approach, we start with the details provided: an upfront cost of $5.39 million, annual revenues of $1.18 million for 10 years, and a cost of capital of 14.8%. The project's future value (FV) of inflows is computed using the compound interest formula, compounding the annual cash inflows at the cost of capital rate over the 10-year period. To solve for the maximum shutdown costs at the end of year 11, you calculate the present value (PV) of the shutdown costs at the cost of capital rate, and then adjust for one additional year.
To meet the project's cost of capital, the present value of the shutdown costs must be equal to or less than the difference between the future value of inflows and the initial investment cost. The formula to calculate this upper limit for shutdown costs is:
FV of inflows / (1 + Cost of capital) - Initial investment
An Excel spreadsheet or financial calculator can be used to perform the necessary financial analysis. If your cost of shutdown is below the calculated maximum amount, then the project would meet its 14.8% cost of capital requirement.