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TREASURY MANAGEMENT
The internal rate of return (IRR) is the rate that equates the investment
outlay with the present value of cash inflow received after one period. This also
implies that the rate of returns the discounted which makes NPV=0(Pandey,
2005)
Cost
10000
Cash inflow
1st year
1000
2nd year
1000
3rd year
2000
4th year
10000
Compute the internal rate of return and comment on the project if the opportunity cost is 14%
Solution:-
Year
Cash inflow
PVF(10%)
PV
PVF(11%)
PV
1000
0.0909
909
0.901
901
1000
0.826
826
0.812
812
2000
0.751
1502
0.731
1462
10,000
0.683
6830
0.659
6590
Total PV of Inflow
10,067
9765
67
-235
IRR = 10% +
67
(1110)
= 10% + 0.22 = 10.22%
67(235)
As the opportunity cost of the firm is 14%, the project having IRR of 10.22 should be rejected.
at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost. By
contrast, the traditional internal rate of return (IRR) assumes the cash flows from a project are
reinvested at the IRR.(INVESTOPEDIA)
Modified Internal Rate of Return, shortly referred to as MIRR, is the internal rate of
return of an investment that is modified to account for the difference between re-investment rate
and investment return. (accounting-simplified)
The modified internal rate of return (MIRR) is the compound average annual rate that is
calculated with a reinvestment rate different than the project IRR(PANDEY, 2005)
Modified IRR method is an attempt to reconcile with NPV method by overcoming the
objective of reinvestment rate. To overcome the drawback of the IRR method and to make it
consistent with the NPV rule, a modified method developed known as modified IRR.
Cash flow
-1000
-4000
5000
2000
4000
NPV = -1000 + (1+r )1
5000
2
(1+r )
2000
3
(1+r )
=0
In this case, the answer is 25.48% (with this conventional pattern of cash flows, the project
has a unique IRR).
To calculate the MIRR, we will assume a finance rate of 10% and a reinvestment rate of 12%.
First, we calculate the present value of the negative cash flows (discounted at the finance rate):
4000
1
(1+10 )
= -4636.36
Second, we calculate the future value of the positive cash flows (reinvested at the reinvestment rate):
FV (Positive cash flows, reinvestment rate) = 5000
(1+12 )
+ 2000 = 7600
MIRR =
MIRR =
7600
4636.36
-1
-1 = 17.91%
The calculated MIRR (17.91%) is significantly different from the IRR (25.48%).
Bibliography
accounting-simplified. (n.d.). Retrieved 08 25, 2016, from accounting-simplified:
http://accounting-simplified.com/management/investment-appraisal/modified-internalrate-of-return-mirr.html
Chandra, P. (2010). Financial managment. In P. Chandra, Financial managment. New
Delhi: Tata McGraw-Hill.
investopedia. (n.d.). Retrieved 08 25, 2016, from investopedia:
http://www.investopedia.com/terms/i/irr.asp