IRR vs. MIRR — What's the Difference?
By Tayyaba Rehman — Published on December 28, 2023
IRR is the rate where a project's net present value is zero, while MIRR considers both the cost of the investment and the interest received on reinvested cash flows.
Difference Between IRR and MIRR
Table of Contents
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Key Differences
IRR and MIRR are both financial metrics used to assess the profitability of investments. However, their methods and implications differ significantly.
IRR, or Internal Rate of Return, determines the discount rate that makes the net present value (NPV) of a project equal to zero. In contrast, MIRR, or Modified Internal Rate of Return, offers a more comprehensive look at profitability by considering the financing cost and the return on reinvested cash flows.
One common criticism of IRR is that it can sometimes provide multiple values for projects with alternating cash flows. MIRR, however, eliminates this ambiguity by providing a single solution, making it a more reliable metric in such scenarios.
While IRR assumes that positive cash flows are reinvested at the IRR itself, MIRR takes a more realistic approach. MIRR assumes cash inflows are reinvested at the project's required rate of return, and the initial outlays are financed at the project's finance rate.
In summation, while IRR provides an initial glance at a project's potential return, MIRR offers a clearer picture by addressing some inherent issues with IRR, making it a more refined measure of a project's potential profitability.
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Comparison Chart
Definition
Discount rate making NPV = 0
Reflects cost of investment and return on reinvested cash flows
Multiple Solutions
Can have more than one value for certain cash flows
Always gives a single value
Reinvestment Assumption
Assumes reinvestment at IRR
Assumes reinvestment at project's required rate of return
Reliability
Less reliable for projects with non-conventional cash flows
More reliable as it provides a more comprehensive view
Consideration of Financing Cost
Does not explicitly consider financing cost
Considers both financing cost and return on reinvested cash flows
Compare with Definitions
IRR
The discount rate at which NPV equals zero.
To break even on the investment, the company needs an IRR of 10%.
MIRR
Eliminates the ambiguity of multiple IRR solutions.
While the IRR method gave two solutions, MIRR offered a clear 12% return.
IRR
Reflects the growth a project is expected to generate.
With an IRR of 15%, the new initiative seems promising.
MIRR
Provides a refined measure of investment profitability.
Considering the financing costs, the MIRR for the project is 9%.
IRR
Determines the desirability of investments or projects.
A higher IRR usually indicates a more attractive investment opportunity.
MIRR
Considers both investment cost and reinvestment returns.
Factoring in all costs and potential returns, the MIRR stands at 8%.
IRR
Can provide multiple values with alternating cash flows.
Due to the project's unconventional cash flows, it yielded multiple IRR values.
MIRR
Assumes reinvestment at the project's required return rate.
Using the MIRR method, cash flows are reinvested at a 7% return rate.
IRR
A measure of an investment's rate of return.
Based on the projected cash flows, the IRR for this project is 8%.
MIRR
More realistic reflection of project's profitability.
Given the reinvestment and financing rates, MIRR provides a comprehensive 10% return estimate.
Common Curiosities
How does IRR determine a project's profitability?
IRR identifies the discount rate at which the project's net present value (NPV) becomes zero.
Which is more reliable, IRR or MIRR?
MIRR is often considered more reliable as it eliminates the ambiguity of IRR and offers a more comprehensive view of an investment's profitability.
What do IRR and MIRR stand for?
IRR stands for Internal Rate of Return and MIRR stands for Modified Internal Rate of Return.
In what scenarios is MIRR preferred over IRR?
MIRR is preferred when considering the reinvestment rate, financing costs, or when IRR provides multiple solutions.
How does MIRR treat reinvested cash flows?
MIRR assumes that cash flows are reinvested at the project's required rate of return.
Does MIRR always provide a single solution?
Yes, MIRR always yields a single value, eliminating the ambiguity that IRR might present in certain scenarios.
Why was MIRR developed as a metric?
MIRR was introduced to address some of IRR's limitations, such as its multiple solution issue and unrealistic reinvestment assumptions.
Can both IRR and MIRR be used for the same project?
Yes, using both can provide a more holistic view of a project's potential profitability.
What is the key difference between IRR and MIRR?
IRR determines the rate for NPV to be zero, while MIRR provides a clearer profitability picture by considering financing and reinvestment rates.
Can IRR sometimes provide misleading results?
Yes, especially for projects with non-conventional cash flows, IRR might give multiple or unrealistic values.
Why is the reinvestment assumption critical in these metrics?
It influences the future value of cash flows, thereby impacting the overall profitability estimation of a project.
Is a higher MIRR always better?
Generally, a higher MIRR indicates a more attractive investment, but other factors should also be considered, such as risks associated with the investment.
How do I interpret a high IRR?
A high IRR typically indicates a potentially attractive investment or project, given its expected rate of return.
Is MIRR always higher than IRR?
Not necessarily. MIRR can be higher, lower, or equal to IRR, depending on financing and reinvestment rates.
How does financing cost influence MIRR?
MIRR takes into account the cost of the investment, impacting the overall rate of return.
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Written by
Tayyaba RehmanTayyaba Rehman is a distinguished writer, currently serving as a primary contributor to askdifference.com. As a researcher in semantics and etymology, Tayyaba's passion for the complexity of languages and their distinctions has found a perfect home on the platform. Tayyaba delves into the intricacies of language, distinguishing between commonly confused words and phrases, thereby providing clarity for readers worldwide.
