Modified Internal Rate Of Return - MIRR

AAA

DEFINITION of '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 positive cash flows are reinvested at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost. Therefore, MIRR more accurately reflects the cost and profitability of a project.

The formula for MIRR is:

 

 

MIRRFormula.gif

INVESTOPEDIA EXPLAINS'Modified Internal Rate Of Return - MIRR'

For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

NPV = 0 = -195 + 121/(1+ IRR) + 131/(1 + IRR)2 NPV = 0 when IRR = 18.66%

To calculate the MIRR of the project, we have to assume that the positive cash flows will be reinvested at the 12% cost of capital. So the future value of the positive cash flows is computed as:

 

$121(1.12) + $131 = $266.52 = Future Value of positive cash flows at t = 2

 

Now you divide the future value of the cash flows by the present value of the initial outlay, which was $195, and find the geometric return for 2 periods.

 

=sqrt($266.52/195) -1 = 16.91% MIRR

 

You can see here that the 16.91% MIRR is materially lower than the IRR of 18.66%. In this case, the IRR gives a too optimistic picture of the potential of the project, while the MIRR gives a more realistic evaluation of the project.

VIDEO

Loading the player...
RELATED TERMS
  1. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  2. Cost Of Capital

    The required return necessary to make a capital budgeting project, ...
  3. Pooled Internal Rate Of Return ...

    A method of calculating the overall internal rate of return (IRR) ...
  4. Discounted Cash Flow - DCF

    A valuation method used to estimate the attractiveness of an ...
  5. Capital Budgeting

    The process in which a business determines whether projects such ...
  6. Cash Flow

    1. A revenue or expense stream that changes a cash account over ...
Related Articles
  1. Economics

    Modified Internal Rate of Return (MIRR)

    Modified internal rate of return (MIRR) is a variant of the more traditional internal rate of return calculation.
  2. Bonds & Fixed Income

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  3. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.
  4. Economics

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
  5. Economics

    What are Barriers to Entry?

    A barrier to entry is any obstacle that restricts or impedes a company’s efforts to enter an industry.
  6. Term

    How Equity Capital Markets Work

    An equity capital market is a market existing between companies and financial institutions that raises money for the companies.
  7. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 500 Trust

    Find out more about the SPDR S&P 500 ETF Trust, the characteristics of the exchange traded fund and the suitability of investing in the fund.
  8. Mutual Funds & ETFs

    ETF Analysis: Energy Select Sector SPDR

    Find out more about the Energy Select Sector SPDR Fund, the top holdings of this exchange-traded fund and the characteristics of the fund.
  9. Investing News

    The Financial Singularity Will Destroy Your Return

    Given the current and future growth of financial technology, many believe algorithms will soon define what drives market outcomes. With a wealth of big data, algorithms would be able to create ...
  10. Economics

    How An Aging World Can Impact Your Portfolio

    It can be easy for investors to lose sight of longer-term, structural developments in favor of more ephemeral trends and fads in the financial markets.
RELATED FAQS
  1. What is the benefit of the Modified Internal Rate Of Return (MIRR)?

    The modified internal rate of return (MIRR) is a financing metric used in business capital budgeting. Its primary benefit ... Read Full Answer >>
  2. What is the formula for calculating the internal rate of return (IRR)?

    Computing the internal rate of return (IRR) for a possible investment is time-consuming and inexact. IRR calculations must ... Read Full Answer >>
  3. What's the difference between net present value and internal rate of return? How ...

    Both of these measurements are primarily used in capital budgeting, the process by which companies determine whether a new ... Read Full Answer >>
  4. Which is a better measure for capital budgeting, IRR or NPV?

    In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Nanny Tax

    A federal tax that must be paid by people who hire household help (a babysitter, maid, gardener, etc.) and pay them a total ...
  2. Dog And Pony Show

    A colloquial term that generally refers to a presentation or seminar to market new products or services to potential buyers.
  3. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  4. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  5. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  6. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!