Economics Capital Budgeting Questions
The modified internal rate of return (MIRR) is a financial metric used in capital budgeting to evaluate the profitability of an investment project. It takes into account the timing of cash flows and assumes that positive cash flows are reinvested at a specified reinvestment rate, while negative cash flows are financed at a specified financing rate.
The MIRR differs from the traditional internal rate of return (IRR) in two main ways. Firstly, the MIRR assumes that positive cash flows are reinvested at the reinvestment rate, which is typically the cost of capital or a hurdle rate, rather than the IRR itself. This reflects a more realistic assumption as it considers the opportunity cost of reinvesting cash flows.
Secondly, the MIRR addresses the issue of multiple IRRs that can occur in complex cash flow patterns. The traditional IRR may result in multiple solutions or no solution at all, making it difficult to interpret. In contrast, the MIRR always provides a single solution, making it easier to compare different investment projects.
Overall, the MIRR is considered a more reliable and accurate measure of an investment's profitability as it considers both the reinvestment rate and the potential for multiple IRRs.