Definition: The Modified Internal Rate of Return or MIRR is a distinct improvement over the internal rate of return that assumes the cash flows generated from the project are reinvested at the firm’s cost of capital rather that at the company’s internal rate of return.
The formula to calculate the Modified Internal Rate of Return is:
Accept-Reject Criteria: If the project’s MIRR is greater than the firm’s cost of capital, accept the proposal.
Merits of Modified Internal Rate of Return
- It takes into consideration the Time Value of Money.
- The entire profitability of the project is taken into the consideration.
- The real project’s profitability can be determined since the cash generated is reinvested at the cost of capital.
- The MIRR gives the same results as that of NPV when the projects are mutually exclusive and are of the same size.
Demerits of Modified Internal Rate of Return
- It is difficult and involves tedious calculations.
- In the case of mutually exclusive projects of different sizes, the conflict may arise.
Thus, the modified internal rate of return gives more realistic and correct picture of the project’s profitability as the cost of capital is more realistic than the IRR rate.