| Modified Internal Rate Of Return |
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Information AboutModified Internal Rate Of Return |
| CATEGORIES ABOUT MODIFIED INTERNAL RATE OF RETURN | |
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IRR suffers from serious drawbacks that are corrected by MIRR. IRR assumes that all Cash Flows generated by an investment are reinvested at the same Rate Of Return as the investment itself, where MIRR assumes that all cash flows are reinvested at the firm's Cost Of Capital . Since most capital investments will have intermediate positive cash flows, the firm will need to reinvest these cash flows, and the firm's cost of capital is a reasonable proxy for the return to be expected. Investments with large or early positive cash flows will tend to look far better with IRR than with MIRR for this reason. To illustrate: a firm has investment options with returns that are generally moderate. An unusually attractive investment opportunity comes up with much higher return. The cash spun off from this latter investment will probably be reinvested at the moderate rate of return rather than in another unusually high-return investment. In this case, IRR will overstate the value of the investment, while MIRR will not. FORMULA MIRR is calculated as follows:
where EXAMPLE Example: Year Cash flow 0 -100 1 + 60 2 + 70 3 + 40 Calculation of NPV: i = interest rate in percent NPV = -100 + 60/ + 70/[(1+i/100)^2 + 40/[{1+i/100)^3] (This calculation is condensed, see the definition of Net Present Value for the full story.) Calculation of MIRR (in percent): NPV = 0 -100 + 60/ + 70/[(1+MIRR/100)^2 + 40/[{1+MIRR/100)^3] = 0 MIRR = 23.77 EXTERNAL LINK |
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