Modified Internal Rate of Return, MIRR

By Yuriy Smirnov Ph.D.

Definition
The modified internal rate of return (MIRR) is a modification of the internal rate of return (IRR)
and is used in capital budgeting as a ranking criterion for mutually exclusive projects. The idea
behind the MIRR method is that all project cash outflows are discounted at the cost of capital, and
all cash inflows are reinvested at the reinvestment rate.

Formula
In general terms, the equation of MIRR can be written as follows:

where N is the number of years (periods) of investment, COF is the cash outflow for a relevant
t

year (period) t, r is the cost of capital (discount rate), CIF is the cash inflow for a relevant year
(period) t, and k is the reinvestment rate.
The left side of the equation is the present value of all a project’s cash outflows (the sing “-” is
needed because cash outflows have negative value). The numerator in the right side of the
formula is the future value (also called terminal value) of a project’s cash inflows. So the equation
above can be modified as shown below.
FV CIF

-PV =COF

(1 + MIRR) N

Finally, the formula for the modified internal rate of return is as follows:

Decision Rule
If the MIRR is the only screening criterion of a project, the decision rule is rather straightforward.
The project should be accepted if the modified internal rate of return is greater than the cost of
capital.
Problems occur in case of ranking mutually exclusive projects, especially if they are of different
size. In such a scenario, the net present value (NPV) should be used as a ranking criterion, and
the MIRR can be used as a supplemental criterion measuring project sensitivity to changes in
cost of capital and reinvestment rates.

Advantages and Disadvantages of the MIRR Method

The modified internal rate of return resolves two problems inherent to the IRR.
i. All cash inflows are reinvested at the reinvestment rate, which is more realistic than reinvesting at
the IRR.
ii. The method of calculation eliminates the problem of multiple IRR for projects with abnormal cash
flows.
The main disadvantage of the MIRR method is the potential conflict with the NPV method. The
reason may be due to a difference in project scale or in the timing of cash flows (the problem was
discussed in “NPV vs IRR method”). Furthermore, if the reinvestment rate is lower than the cost
of capital, there is a conflict with the basic assumption of the NPV method, which is that all
expected cash inflows are reinvested at the cost of capital (discount rate). Thus, the project can
simultaneously have positive NPV and MIRR lower than the cost of capital. That is the reason
why some academic studies recommend using the reinvestment rate equal to the cost of capital
raised for a project.

Example
Company N is considering two mutually exclusive projects. The cost of capital is 12%, and the
expected reinvestment rate is 10%. Detailed information about expected cash flows is presented
in the table below.
Initial Cost, CF0 Cash flows at the end of relevant year, CFt
0 1 2 3 4 5
Project Y -$20,000,000 -$5,000,000 $12,000,000 $10,500,000 $9,000,000 $8,500,000
Project Z -$20,000,000 $11,000,000 $9,000,000 $7,500,000 $6,000,000 -$5,000,000

Please note that Project Z has abnormal cash flows, so we have the multiple IRR problem.
To solve the equation above, we need to calculate the present value (PVCOF) of all cash
outflows and the future (terminal) value of all cash inflows (TV) for both projects.

-$20,000,000 -$5,000,000
PV COF of Project Y = + = -$24,464,285.71
(1 + 0.12) 0
(1 + 0.12) 1

-$20,000,000 -$5,000,000
PV COF of Project Z = + = -$22,837,134.28
(1 + 0.12)0
(1 + 0.12) 5

FV of Project Y = $12,000,000 × (1 + 0.1) + $10,500,000 × (1 + 0.1) + $9,000,000 × (1 + 0.1) +

CIF
3 2 1

$8,500,000 × (1 + 0.1) = $47,077,000

0

FV of Project Z = $11,000,000 × (1 + 0.1) + $9,000,000 × (1 + 0.1) + $7,500,000 × (1 + 0.1) +

CIF
4 3 2

$6,000,000 × (1 + 0.1) = $43,759,100

1

Schematically, cash inflows and outflows of both projects are presented in the figure below.
Thus, the MIRR of Project Y is 13.99% and 13.89% for Project Z.

Both projects have the MIRR greater than the cost of capital, so they could be accepted if they
were independent. Because they are mutually exclusive, Project Y should be accepted, and
Project Z should be rejected. On the other hand, the NPV of Project Y is $3,118,524.40 and
$3,310,499.52 for Project Z. Thus, there is a conflict between the NPV and the MIRR method. In
such cases, it is recommended that the NPV be used as a single screening criterion, so Project Z
should then be accepted. We should note, though, that Project Z is more sensitive to change in
the cost of capital and the reinvestment rate than Project Y.
MIRR in Excel
The modified internal rate of return can be also calculated in Excel as in the example below.
 i. Select output cell H7.
ii. Click fx button, select All category, and select MIRR function from the list.
iii. In field Values, select the data range B7:G7.
iv. In field Finance_rate, select cell B1.
v. In field Reinvest_rate, select cell B2, and press OK button.
So we have the same MIRR of Project Y of 13.99% and 13.89% for Project Z.