What is Modified Internal Rate of Return

Modified internal rate of return or MIRR is the improvement in IRR. One of the weak point of IRR’s assumption that we reinvest past cash flow at internal rate of return.  But this is not true assumption. Reinvestment should be at cost of capital. But in MIRR, we assume that all cash flow will be reinvested at cost of capital. So, MIRR is more realistic than IRR. With modified internal rate of return, we can evaluate the project better way.

Abraham A., who is responsible for writing Think and Done, shares its correct definition

MIRR value is always unique given that we have at least one negative and one positive net cash flow. The modified internal rate of return is a geometric average of the compounded future value of positive cash flows over the discounted present value of negative cash flows. MIRR is calculated by first finding the future value of positive cash flows (net benefits) and present value of costs (net costs). The final calculation calculates the geometric mean or geometric average for these future and present values. MIRR calculation uses a closed form MIRR formula that always produces results given that at least one of the cash flows is positive and at least one of the cash flows is negative.

Formula of MIRR as per Wikipedia

 

Explanation of Modified Internal Rate of Return Through Examples 

1. As per the given example of investopedia, MIRR will be 16.91% 

=sqrt($266.52/195) -1 = 16.91% MIRR which will be more realistic than IRR of 18.66% because cost of capital is just 12%

{ Important : If you are interested to know whether past cash flow is reinvested at IRR, you should study the comment of Joseph Todd at CFO.Com on the written content Internal Rate of Return: A Cautionary Tale}