FIN 614: Financial Management Larry Schrenk, Instructor.

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FIN 614: Financial Management Larry Schrenk, Instructor

1.What is Modified Internal Rate of Return? 2.Calculating Modified Internal Rate of Return 3.Analysis of Modified Internal Rate of Return

Allows the reinvestment rate (r RI ) of cash flows to be specified. Allows the reinvestment rate (r RI ) of cash flows to be different than the discount rate.

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.

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

Steps: 1.Determine all cash flows. 2.Find the future value (in the last year) of all cash inflows compounded at r RI. 3.Find the present value of all cash outflows. 4.Find the MIRR, the discount rate that makes the present value of all cash outflows equal to the present value of the terminal value.

-C 0 C1C1 C2C2 C3C3 C4C4 FV(C 3 ) FV(C 4 ) FV(C 2 ) FV(C 1 ) |-C 0 | = Total FV C 3 (1+r RI ) C 2 (1+r RI ) 2 Total FV (1+MIRR) 4 C 1 (1+r RI ) 3 MIRR is the discount rate that makes PV(Total FV) =|C 0 | PV(Total FV) =

EXAMPLE (r RI = 10%): MIRR Step 1: Determine Cash Flows ,

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

EXAMPLE (r RI = 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, ,

EXAMPLE (r RI = 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 = Result: 15.53% > 10% Good Project ,

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.

FIN 614: Financial Management Larry Schrenk, Instructor