Section 13: Investment Analysis

149

This Modified Internal Rate of Return procedure (MIRR) is one of several IRR alternatives which avoids the drawbacks of the traditional IRR technique. The procedure eliminates the sign change problem and the reinvestment (or discounting) assumption by utilizing user stipulated reinvestment and borrowing rates.

Negative cash flows are discounted at a safe rate that reflects the return on an investment in a liquid account. The figure generally used is a short-term security (T-Bill) or bank passbook rate.

Positive cash flows are reinvested at a reinvestment rate which reflects the return on an investment of comparable risk. An average return rate on recent market investments might be used.

The steps in the procedure are:

1.Calculate the future value of the positive cash flows (NFV) at the reinvestment rate.

2.Calculate the present value of the negative cash flows (NPV) at the safe rate.

3.Knowing n, PV, and FV, solve for i.

Example: An investor has the following unconventional investment opportunity. The cash flows are:

Group# of MonthsCash Flow ($)

 

 

 

0

1

–180,000

1

5

100,000

2

5

–100,000

3

9

0

4

1

200,000

 

 

 

Calculate the MIRR using a safe rate of 6% and a reinvestment (risk) rate of 10%.

Keystrokes

Display

fCLEARH

0.00

0gJ

0.00

100000gK

 

5ga

5.00

0gK5ga

5.00

0gK9ga

9.00

200000gK

200,000.00

First cash flow.

Second through sixth cash flows.

Next five cash flows.

Next nine cash flows.

Last cash flow.

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