Loading the player...

What is 'Modified Internal Rate Of Return - MIRR'

Modified internal rate of return (MIRR) 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. By contrast, the traditional internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR. The MIRR more accurately reflects the cost and profitability of a project.

MIRRFormula.gif

BREAKING DOWN 'Modified Internal Rate Of Return - MIRR'

The MIRR is used to rank investments or projects of unequal size. The calculation is a solution to two major problems that exist with the popular IRR calculation. The first main problem with IRR is that multiple solutions can be found for the same project. The second problem is that the assumption that positive cash flows are reinvested at the IRR is considered impractical in practice. With the MIRR, only a single solution exists for a given project, and reinvestment rate of positive cash flows is much more valid in practice.

Calculating the Modified Internal Rate of Return and Example

The formula for the MIRR takes into account three variables. They are:

FVCF(c) = the future value of positive cash flows at the cost of capital for the company

PVCF(fc) = the present value of negative cash flows at the financing cost of the company

n = number of periods

Given the variables, the formula for MIRR is:

MIRR = ( FVCF(c) / PVCF(fc) ) ^ ( 1 / n ) -1

A basic IRR calculation is as follows. Assume that 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), when IRR = 18.66%.

To calculate the MIRR of the project, assume that the positive cash flows will be reinvested at the 12% cost of capital. Therefore, 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

Next, 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.

Finally, adjust this ratio for the time period using the formula for MIRR given:

MIRR = ($266.52 / $195) ^ (1 / 2) - 1 = 1.1691 - 1 = 16.91%

In this particular example, the IRR gives an overly optimistic picture of the potential of the project, while the MIRR gives a more realistic evaluation of the project.

RELATED TERMS
  1. IRR

    The currency abbreviation or currency symbol for the Iranian ...
  2. Unconventional Cash Flow

    An unconventional cash flow is a series of inward and outward ...
  3. Financial Management Rate Of Return ...

    The financial management rate of return is a real estate measure ...
  4. Initial Cash Flow

    Initial cash flow is the amount of money paid out or received ...
  5. Profitability Index

    The profitability index is a technique used to measure a proposed ...
  6. Price to Free Cash Flow

    Price to free cash flow is an equity valuation metric used to ...
Related Articles
  1. Investing

    Internal rate of return: An inside look

    The internal rate of return can be used to measure an compare capital projects, stock buyback programs, and investments to determine which will yield the most favorable return.
  2. Investing

    Internal Rate of Return Formula for Excel

    The internal rate of return, or IRR, is a popular metric businesses use to measure a project’s return on investment.
  3. Financial Advisor

    Understanding Internal Rate Of Return

    Internal rate of return, or IRR, is one of the most popular methods of evaluating potential projects. Learn more about this important metric.
  4. Tech

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  5. Small Business

    Understanding Cash Flow

    Learn about the different types of cash flows and the importance for businesses to properly manage their cash flows.
  6. Investing

    Cash Flow on Steroids: Why Companies Cheat

    Pressure to be the best can sometimes push corporations to cheat. Learn how they do it and how to spot it.
RELATED FAQS
  1. Which is better for capital budgeting – IRR or NPV?

    All other things being equal, using IRR and NPV measurements to evaluate projects often results in the same findings. However, ... Read Answer >>
  2. What is the formula for calculating the internal rate of return (IRR)?

    Learn about the internal rate of return, an important concept in determining the relative attractiveness of different investments. Read Answer >>
  3. What's the difference between weighted average cost of capital (WACC) and internal ...

    Both weighted average cost of capital (WACC) and internal rate of return (IRR) are great measures for assessing value, but ... Read Answer >>
  4. How do hurdle rate MARR and internal rate of return IRR relate?

    In capital budgeting, projects are evaluated by comparing the internal rate of return (IRR) to the hurdle rate, also known ... Read Answer >>
  5. How do you use discounted cash flow to calculate a capital budget?

    Learn how discounted cash flows are used in creating capital budgets as a part of the net present value and internal rate ... Read Answer >>
Trading Center