Calculating Modified Internal Rate of Return

MIRR is an alternative to the traditional calculation of the IRR in that it computes an IRR with an explicit reinvestment rate assumption.

The discount rate that equates the present value of all negative cash flows (including the down payment) to the future or terminal value of all the positive cash flows is the MIRR.

While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm’s cost of capital. Therefore, MIRR more accurately reflects the profitability of a project.

For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

Thus, using the IRR could result in a positive NPV (good project), but it could turn out to be a bad project (NPV is negative) if the MIRR were used. As a result, using MIRR versus IRR better reflects the value of a project.

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Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.