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Video 35 (Topic 7.2.3): Modified Internal Rate of Return (MIRR)

Video 35 (Topic 7.2.3): Modified Internal Rate of Return (MIRR). FIN 614: Financial Management Larry Schrenk, Instructor. Topics. What is Modified Internal Rate of Return? Calculating Modified Internal Rate of Return Analysis of Modified Internal Rate of Return. ‘ Modification ’.

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Video 35 (Topic 7.2.3): Modified Internal Rate of Return (MIRR)

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  1. Video 35 (Topic 7.2.3):Modified Internal Rate of Return (MIRR) FIN 614: Financial Management Larry Schrenk, Instructor

  2. Topics • What is Modified Internal Rate of Return? • Calculating Modified Internal Rate of Return • Analysis of Modified Internal Rate of Return

  3. ‘Modification’ • Allows the reinvestment rate (rRI) of cash flows to be specified. • Allows the reinvestment rate (rRI) of cash flows to be different than the discount rate.

  4. Modified Internal Rate of Return (MIRR) • MIRR is the discount rate that makes present value of all cash outflows equal to the present value of all cash inflows. • NOTE: No calculator function for MIRR.

  5. MIRR Rule • Rule: Do project if MIRR > required rate of return (r). • If the return on the project (MIRR) is greater than the return expected on projects with this level of risk (r), then do the project

  6. MIRR Process • Steps: • Determine all cash flows. • Find the future value (in the last year) of all cash inflows compounded at rRI. • Find the present value of all cash outflows. • Find the MIRR, the discount rate that makes the present value of all cash outflows equal to the present value of the terminal value.

  7. MIRR Diagram▪ -C0 C1 C2 C3 C4 MIRR is the discount rate that makes PV(Total FV) =|C0| FV(C4) + C3(1+rRI) FV(C3) + C2(1+rRI)2 FV(C2) + C1(1+rRI)3 |-C0| FV(C1) = = PV(Total FV) Total FV Total FV (1+MIRR)4

  8. MIRR Example 1 • EXAMPLE (rRI= 10%): • MIRR Step 1: Determine Cash Flows

  9. MIRR Example 2 • EXAMPLE (rRI= 10%): • MIRR Step 2: Find the future value (in the last year) of all cash inflows compounded at rRI. • This can be done on your calculator.

  10. MIRR Example 3 • EXAMPLE (rRI= 10%): • MIRR Step 3: Find the present value of all cash outflows. • The only cash outflow is at t = 0 and its present value is -1,000.

  11. MIRR Example 4 • EXAMPLE (rRI= 10%): • MIRR Step 4: Find the MIRR that makes the present value of all cash outflows equal to the present value of the terminal value. N = 4; I% = 15.53%; PV = -1000; PMT = 0; FV = 1781.30 • Result: 15.53% > 10% Good Project

  12. MIRR: Analysis • MIRR is better than IRR because: • MIRR can specific the reinvestment rate • MIRR avoids the problem of multiple IRR's • But MIRR still has the same problems as IRR when it is used to compare projects.

  13. Video 35 (Topic 7.2.3):Modified Internal Rate of Return (MIRR) FIN 614: Financial Management Larry Schrenk, Instructor

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