What is Modified Internal Rate of Return?

The modified internal rate of return ( M IRR) is the discount rate at which the present value of a project’s cost is equal to the present value of its terminal value, where the terminal value is found as the sum of the future values of the cash inflows, compounded at the firm’s cost of capital.

It is logical for managers to want to know the expected rate of return on investments, and this is what the IRR is supposed to tell them. However, the IRR is based on the assu mption that projects’ cash flows can be reinvested at the IRR . This assumption is generally incorrect, and this causes the IRR to overstate the project’s true return. Given this fundamental flaw, we can modify the IRR to make it a better measure of profita bility. This new measure is called the modified IRR or MIRR. Another advantage of using MIRR is that the MIRR eliminates the multiple IRR problem. There can never be more than on MIRR, and it can be compared with the cost of capital when deciding to accept or reject projects.

How to Calculate Modified Internal Rate of Return?

The formula to calculate Modified internal rate of return is:
Where:
C_t = Net cash inflow during the period t
RI = The reinvestment Rate
IRR = The internal rate of return
t = The number of time periods

Suppose that you are going to invest $1,000 and receive a 4 yearly cashflows of $500, $400, $300, and $100. If your reinvestment rate or weighted average cost of capital (WACC) is 10%, y ou might one to know the modified internal rate of return (MIRR) of your investment. Here is the mathematical equation of the problem:

How to use Modified Internal Rate of Return Calculator?

Let’s assume that you have an investment opportunity that requires you to invest $1,000 that will give you 4 different cash inflows. If the reinvestment rate is 10%, you may want to know the modified IRR that makes the investment’s NPV equal to Zero . Make the following entries in our c alculator.

Initial Investment: This number is by default a negative number. What it means is that investment into the project is always a cash outflow (negative number) from you. In finance, investment is always defined as a negative number. You need to enter your initial investment amount as $1,000.

Number of Cash Flows: From the dropdown box, select how many yearly cash flows input boxes you want for your project. Let’s assume that your investment has 4 cash in flows. Therefore, select, 4 from the list.

Cash Flows: Depending on the number of cash flow input boxes you selected, you need to enter all cash flows. For example, for your investment, enter $500, $400, $300 and $100.

Financing Rate: This input box will remain disabled as long as none of the CFs you have entered is negative. If you enter negative CFs in any of the input boxes , you will also need to enter financing rate. This rate is the cost of borrowing money or the interest rate to borrow money.

Once you have entered all the numbers as stated above, click on “Calculate” button. The calculator will show you the modified internal rate of return (MIRR) of 12.106%. The breakdown of the NPV calculation is given in the results table where in the sum of the future values of the cash inflows are equal to initial investment.