Business

Difference between IRR and MIRR

Main difference

The main difference between the IRR and the MIRR is that the IRR (the internal rate of return) is an interest rate whenever the NPV is equal to zero and the MIRR (modified internal rate of return) is the rate of return whenever the NPV of the terminal inputs is equal to the output.

IRR versus MIRR

The internal rate of return (IRR) metric is common among business managers; it tends to overstate the profitability of a project and can lead to capital budgeting errors based on an overly optimistic estimate. The modified internal rate of return (MIRR) compensates for this failure and gives managers more control over the assumed rate of reinvestment of future cash flow. When a project has different durations of positive and negative cash flows. In these cases, the IRR generates more than one number, which creates uncertainty and confusion. MIRR also solves this problem or problem. IRR is more of an optimistic view of returns, while MIRR is a realistic view.

Comparison chart

IRR MIRR
The IRR is a procedure for calculating the rate of return taking into account internal factors, that is, excluding the cost of capital and inflation. MIRR is a capital budgeting procedure that calculates the rate of return using the cost of capital and is used to rank multiple investments of equal size.
What’s the matter
It is the value at which NPV equals zero. It is the value at which the NPV of the terminal inputs is equal to the output, that is, the investment.
Accuracy
Under comparatively high
Assumption
Project cash flows reinvested at project IRR. Project cash flows are reinvested at cost of capital.

What is the IRR?

The Internal Rate of Return (IRR) is an economic resource for cash flow analysis, popular for evaluating the performance of investments, capital raising, project proposals, programs, and business case scenarios. IRR analysis begins with an income stream or cash flow, a series of expected net cash flow outcomes of equity (or action scenario, acquisition, or business case). Most people in business have at least heard of the “internal rate of return.” The name is common because financial officials often need an IRR estimate to support budget requests or proposals for action. IRR is one of the favorite metrics of many CFOs, controllers, and other financial specialists. What’s more, IRR is known to some business owners because many organizations define a hurdle rate as an IRR. They define, that is,

Reasons for the popularity of the IRR

  • First, many in the financial group see IRR as more “objective” than Net Present Value (NPV). They take this view because the NPV results from randomly chosen discount rates, while the IRR, by contrast, results entirely from the cash flow figures themselves and their timing.
  • Second, IRR is also judged by some to readily compare rates of return with inflation, current interest rates, and financial investment alternatives. Note especially in the discussions below that this belief is sometimes supported and sometimes not.

What is the MIRR?

MIRR (Modified Internal Rate of Return) intends for positive cash flows to be paid back into the company’s cost of capital and for start-up expenses to be financed out of the company’s cost of financing. The MIRR, therefore, more accurately considers the cost and profitability of a project. The MIRR is used to rate investments or projects of unequal size. With MIRR, only a single solution is produced for a given project, and the reinvestment rate of positive cash flows is much more legitimate in practice. The MIRR allows project managers to change the assumed reinvested growth rate from one phase to another in a project. The most common method is to enter the estimated ordinary cost of capital, but there is the ability to add any specific early rollover rate. MIRR improves IRR by assuming that positive cash flows are reinvested at the firm’s cost of capital. MIRR tends to classify investments or projects that a company or inventors may undertake. MIRR is designed to produce a solution, eliminating the problem of multiple IRRs.

Advantages

  • MIRR overcomes two main drawbacks of IRR containing the elimination of multiple IRRs in the case of investments with unusual timing of cash flows, and second, the reinvestment problem discussed above.
  • Helps in measuring the sensitivity of the investment to variations in the cost of capital.

Key differences

  1. The Internal Rate of Return or IRR establishes a method to calculate the discount rate considering internal factors, that is, except the cost of capital and inflation. On the other hand, MIRR refers to the capital budgeting method, which calculates the rate of return taking into account the cost of capital. It is used to classify several investments of the same size.
  2. IRR based on the principle that provisional cash flows are reinvested at the IRR of the project. Unlike MIRR, cash flows in addition to the initial cash flows are reinvested at the company’s interest rate.
  3. The internal rate of return becomes a rate of return or rate of return where the NPV equals zero. On the contrary, MIRR is the rate of return over which the NPV of the terminal inputs is equal to the output, that is, the investment.
  4. The MIRR sentence is more than the IRR, since MIRR estimates the true rate of return.

Final Thought

The completion measure of both operating budgeting methods is the same, but the MIRR describes a better return than the IRR, due to two main reasons, i.e., firstly, the reinvestment of cash flows at the expense of the capital is really possible, and secondly, numerous rates of return do not subsist in the case of MIRR.

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