02 Jun Modified Internal Rate of Return (MIRR)
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Definition: The Modified Internal Rate of Return (MIRR) is a financial formula that is used to compare the return that a project can provide. As its name suggests, it is a modified version of the Internal Rate of Return (IRR) calculation.
What is Modified Internal Rate of Return (MIRR)?
What is the difference between MIRR and IRR? To understand this, you must first know that both calculations use the cash flows from a project to work out the return that a company will earn. A project could have a large cash outflow at the beginning and subsequently there could be inflows in the following years. In the IRR calculation, it is assumed that the inflows are reinvested by the company at the same rate as the IRR. However, this may not be a correct assumption because a firm may not have the opportunity to reinvest inflows at this rate. The MIRR calculation assumes that the inflows are reinvested at the firm’s cost of capital. This could be a more realistic assumption. When calculating MIRR it is also assumed that the initial outlays are financed at the firm’s financing cost.
What does MIRR mean?
The following example will help to explain the difference between IRR and MIRR. Consider a project that results in an outflow of $250,000 in year 1 and provides a positive cash flow of $45,000 in years 2, 3, 4, and 5. At the end of year 5, the project provides an inflow of $295,000, which is the original investment of $250,000 along with a return of $45,000. The cash flows can be summarized as follows:
Example of MIRR
- Year 1: -$250,000
- Year 2: $45,000
- Year 3: $45,000
- Year 4: $45,000
- Year 5: $45,000
- End of Year 5: $295,000
MIRR is considered to be a more realistic measure than IRR because it is not always possible for a firm to reinvest cash inflows at the project’s rate.