The Modified Internal Rate of Return (MIRR) is a financial metric used to evaluate the attractiveness of an investment. Unlike the traditional Internal Rate of Return (IRR), it addresses some of the IRR’s shortcomings by assuming that positive cash flows are reinvested at the project’s cost of capital, while negative cash flows are financed at the firm’s financing cost. A computational tool, often a spreadsheet or financial calculator, is essential for determining this value due to the complex calculations involved. For instance, consider a project with an initial outlay of $1,000 and subsequent cash inflows. Calculating the MIRR involves finding the future value of these inflows at the reinvestment rate and the present value of the outlay at the financing rate. The MIRR is then the discount rate that equates these two values.
This metric provides a more realistic assessment of an investment’s profitability, especially when dealing with unconventional cash flows or comparing projects with different scales or timelines. Its development arose from criticisms of the IRR’s assumptions about reinvestment rates, which could lead to overly optimistic projections. By incorporating distinct reinvestment and financing rates, it offers a more nuanced perspective and helps avoid potentially misleading investment decisions. This is particularly valuable in complex capital budgeting scenarios.
