Modified Internal Rate of Return - MIRR

Modified Internal Rate of Return - MIRR

While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm's cost of capital. Therefore, MIRR more accurately reflects the profitability of a project.

Notes:

For example, say a two-year project will cost $231 with a cost of capital of 12% and that it will return $110 in the first year and $121 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

NPV = 0 = -195 + 110/(1+ IRR) + 121/(1 + IRR)² NPV = 5 when IRR = 10%

Solving for NPV using MIRR, we will replace the IRR with our MIRR = cost of capital of 12% :

NPV = -195 + 110/(1+ .12) + 121/(1 + .12)² NPV = -0.32 when MIRR = 12%

Thus, using the IRR could result in a positive NPV (good project), but it could turn out to be a bad project (NPV is negative) if the MIRR were used. As a result, using MIRR versus IRR better reflects the value of a project.

See also: Capital Budgeting, Cash Flow, Cost of Capital, Discounted Cash Flow - DCF, Internal Rate of Return - IRR, Net Present Value - NPV, Payback Period