IRR vs. MIRR

Introduction

Within the last 60 years, Internal Rate of Return (IRR) and Net Present Value (NPV) became the choice of management and decision makers as a tool of measuring financial evaluation of opportunities for investment. To date, both tools have been used in different situations for evaluation: in the evaluation of equipment, property, company acquisition, offshore production, new product, production decision, and decision for closing company (Kierulff, 2008).

Although NPV and IRR are much more popular nowadays, both tools are not designs to effectively deal with the enormous problems of investment - in an area where periodic flows of cash are produced connecting the time of purchase and sale of the asset. MIRR was first introduced in the 1950s that account for the flows of cash (Biondi, 2006; Baldwin, 1959).

Despite being the better tool for valuation, MIRR could not get the attention it deserves. However, some academics have given positive opinions for MIRR in text books with little attention (Wiar, 1973; Schafrick& Hartman, 2004; McCarty, McDaniel, &Jessell, 1988; Athanasopoulos, 1978; Kennedy & Plath, 1994). It was observed that very few noted the superiority of MIRR over other valuation techniques such as IRR. It is observed in a survey that only 9.3% firms use MIRR for 75-100% of the time when evaluating a project or investment (Rayan&Rayan, 2002).

Discussion

However, the extensive use of IRR and NPV in companies all around the world with their major limitations, MIRR should be given priority and appreciation. It is notable that MIRR is explained well in rectifying problems, which misused and misunderstood before (Kierulff, 2008).

Most of the computer spreadsheets program are provided with MIRR calculation, but cannot properly covers the cash flows concerned. This paper describes the problem with IRR and NPV, explanation of MIRR working and description of how MIRR reduced the problems.

Since W last 60 years, Internal Rate of Return (IRR) and Net Present Value (NPV) became the choice of management and decision makers as a tool of measuring financial evaluation of opportunities for investment. Till date, both tools have been used in different situations for evaluation: in the evaluation of equipment, property, company acquisition, offshore production, new product, production decision, and decision for closing company (Kierulff, 2008).

NPV basically discounts the future cash inflows of an investment at a rate which is based on three factors: expected inflation, the investment's risk, and the value of cash for the investor when opportunity ends. NPV is positive and attractive when a discounted cash inflow exceeds the amount required for the project.

IRR is the tool used to calculate the rate of return of an opportunity; it returns a rate which equals the future cash inflows to cash outflows. The opportunity is said to have financial attraction when IRR is greater that rate required by the investor. MIRR is derivative of IRR and provide more accurate measures of an opportunity and also avoids future risks.

Problem with IRR and NPV

NPV basically discounts the future cash inflows of an investment at a rate which is based on three factors: ...