Question
Modified Internal Rate of Return (MIRR) which handles the multiple IRR problem by combining cash flows until only one change of sign remains. There are
Modified Internal Rate of Return (MIRR) which handles the multiple IRR problem by combining cash flows until only one change of sign remains. There are multiple ways of achieving this, the one I prefer, and use in the Investment Criteria Template, is achieved by carrying all cash flows, except the initial one, to the last year of the project using the discount rate, then calculating the IRR for the modified set of cash flows.
As an example, consider a project where you invest $100 now, and get cash flows of $75, $200, and -$120 for the following three years. Assume that appropriate discount rate is 10%.
Since there are two sign changes, the equation that defines IRR has two solutions (verify this for yourself): -42.92% and 54.23%. Since it is not necessarily clear which or any one the two rates is the proper IRR, we calculate the modified IRR. First, note that the Year 1 cash flow of $75 is worth $75 x 1.10 x 1.10 = $90.75 in Year 3, and the Year 2 cash flow of $200 is worth $200 x 1.10 = $220 in Year 3. Hence, the cash flows of years 1-3 are worth a combined $90.75+$220-$120 = $190.75 at the end of Year 3. MIRR is then calculated by calculating IRR for a modified project where initial investment is still $100, and future cash flows are $0, $0, and $190.75 for the following three years. Making the calculation we find out that MIRR is 24.02%.
Controversial Claim We liked IRR because it allowed us to express a rate of return without needing the discount rate. MIRR, however it is calculated, has to employ the discount rate in order to calculate a rate of return. However, MIRR is not a true INTERNAL rate of return, hence should not be used to express or convey a rate of return
Objective Students are expected to argue in favor of positions they may not necessarily agree with, and in the process, learn to understand where opposing views come from. Such skills are necessary to stay away from "incestuous amplification" that arises from groups of people who think alike.
You are required to defend the statement made (Controversial Claim) as if it was made in a court of law in front of a judge.
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