Modified Internal Rate of Return (MIRR)
Candlefocus EditorOne biggest difference between MIRR and IRR is the way negative cash flows are treated. IRR assumes negative cash flows must be reinvested in an environment with the same rate of return. MIRR, on the other hand, assumes that reinvested cash flows are invested at the firm's cost of capital. This provides a more realistic calculation of total return and a more accurate comparison of two projects or investments.
The second major difference between MIRR and IRR is that MIRR is designed to generate only one solution, eliminating the problem of multiple IRRs. Further, MIRR is designed to calculate total return over the entire period, not just the final rate of return. This makes MIRR an ideal tool for comparing projects or investments with different cash flows, as it will provide an overall return.
MIRR is also an attractive tool as it provides a more concrete measure of profitability as it uses a standard interest rate for comparison. For example, two projects with the same IRR, but different reinvestment rates, will yield different results when calculated using MIRR.
Overall, MIRR is a powerful tool for making capital budget decisions. By assuming positive cash flows are reinvested at a firm's cost of capital, providing only one solution, and focusing on overall return rather than just the final rate of return, MIRR provides businesses and investors with a tool for evaluating projects and investments with increased accuracy.