Modified Internal Rate of Return
- Modified Internal Rate of Return
Modified Internal Rate of Return (MIRR) is a financial measure used to determine the attractiveness of an investment. It is generally used as part of a capital budgeting process to rank various alternative choices. As the name implies, MIRR is a modification of the financial measure Internal Rate of Return (IRR). The main difference is that it is a measure for the rate of return on the whole capital during the whole duration of the project.
The modified internal rate of return assumes all positive cash flows are re-invested (usually at the WACC) for the remaining duration of the project. All negative cash flows are discounted and included in the initial investment outlay. MIRR ranks project efficiency consistent with the present worth ratio (variant of NPV/Discounted Negative Cash Flow), considered the gold standard in many finance textbooks. [Principles of Corporate Finance, Brealey, Myers, and Allen] [Economic Evaluation and Investment Decision Methods, Stermole and Stermole]
Problems with IRR
A problem of the IRR is that it ignores the reinvestment potential of intermediate positive cash flows. Unless a better number is known, the firm's cost of capital is a reasonable proxy for the return to be expected.
In the case of a project with an unusually high IRR, the cash spun off from it will probably be reinvested at a moderate rate of return rather than in another unusually high-return investment. This mitigates the attractiveness of the project, which is reflected in the MIRR. Conversely, this reinvestment also mitigates the unattractiveness of an unsuccessful project, which is also reflected in the MIRR.
Similarly, money reserved for negative cash flows after the start of the project cannot be expected to have the same unusually high or low rate of return as the project itself perhaps has, so a normal rate of return is assumed for this money until it goes into the project.
Formula
MIRR is calculated as follows:
where "n" is the number of cash flows (at evenly spaced times), "q" is the value at the time of the last cash flow of the positive cash flows, computed according to the reinvest rate, divided by the net present value of the negative cash flows, computed according to the finance rate.
References
External links
* [http://www.thinkanddone.com/finance/mirr.html MIRR Online Calculator]
* [http://www.cfo.com/article.cfm/3304945 Internal Rate of Return: A Cautionary Tale]
Wikimedia Foundation.
2010.
Look at other dictionaries:
Modified internal rate of return — The modified internal rate of return (MIRR) is a financial measure of an investment s attractiveness.[1][2] It is used in capital budgeting to rank alternative investments of equal size. As the name implies, MIRR is a modification of the internal … Wikipedia
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… … Investment dictionary
Internal rate of return — The internal rate of return (IRR) is a capital budgeting metric used by firms to decide whether they should make investments. It is an indicator of the efficiency or quality of an investment, as opposed to net present value (NPV), which indicates … Wikipedia
The Net Internal Rate Of Return - Net IRR — A measure of a portfolio or fund s performance that is equal to the internal rate of return (IRR) after management fees and carried interest have been accounted for. It is a capital budgeting and portfolio management term. The IRR is a discount… … Investment dictionary
Rate of return — In finance, rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested.… … Wikipedia
Modified Dietz Method — The Modified Dietz Method is a calculation used to determine an approximation of the performance of an investment portfolio based on money weighted cash flow.[1] A more precise way of calculating performance in the presence of external cash flows … Wikipedia
Royalty rate assessment — is a practical tool to gauge the impact of a royalty commitment in a technology contract to the business interests of the contracting parties. In this coverage, the terms royalty , royalty rate and royalties are used interchangeably.A firm with… … Wikipedia
Capital budgeting — (or investment appraisal) is the planning process used to determine whether a firm s long term investments such as new machinery, replacement machinery, new plants, new products, and research and development projects are worth pursuing.Many… … Wikipedia
Net present value — In finance, the net present value (NPV) or net present worth (NPW)[1] of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity. In the case when… … Wikipedia
List of finance topics — Topics in finance include:Fundamental financial concepts* Finance an overview ** Arbitrage ** Capital (economics) ** Capital asset pricing model ** Cash flow ** Cash flow matching ** Debt *** Default *** Consumer debt *** Debt consolidation ***… … Wikipedia
