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 value 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. Payback Period

    The length of time required to recover the cost of an investment. ...
  5. Cash Flow

    1. A revenue or expense stream that changes a cash account over ...
  6. Capital Budgeting

    The process in which a business determines whether projects such ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. What does the rule of 70 indicate about a country's future economic growth?

    The rule of 70 could be used to indicate the approximate number of years that it would take a company's economic growth to ... Read Full Answer >>
  5. How is the rule of 70 related to the growth rate of a variable?

    The rule of 70 is related to the growth rate of a variable because it uses the growth rate in its approximation of the number ... Read Full Answer >>
  6. What are the benefits of using ceteris paribus assumptions in economics?

    Most, though not all, economists rely on ceteris paribus conditions to build and test economic models. The reason they do ... Read Full Answer >>
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. Fundamental Analysis

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  5. Economics

    What is Deadweight Loss?

    Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  6. Economics

    How to Do a Cost-Benefit Analysis

    The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted.
  7. Fundamental Analysis

    Calculating the Herfindahl-Hirschman Index (HHI)

    The Herfindhal-Hirschman Index, (HHI) is a measure of market concentration and competition among market participants.
  8. Investing

    How To Implement A Smart Beta Investing Strategy

    Smart beta investing is the notion of re-writing investment rules to improve investment outcomes by targeting exposures to intuitive ideas or factors.
  9. Investing

    Market Crisis: Does Diversification Still Work?

    If you still aren’t sold on the benefits of international diversification, you may object that: Diversification didn’t work during the last market crisis.
  10. Economics

    Explaining the Value Chain

    A model of how businesses receive raw materials as input, add value to the raw materials, and sell finished products to customers.

You May Also Like

Hot Definitions
  1. Butterfly Spread

    A neutral option strategy combining bull and bear spreads. Butterfly spreads use four option contracts with the same expiration ...
  2. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  3. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  6. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
Trading Center