What it means
The ordinary internal rate of return quietly assumes that every dollar a project throws off can be reinvested at the same rate the project earns. For a project showing 30%, that assumption is heroic, because few businesses have an endless supply of 30% opportunities waiting for the cash.
MIRR replaces that assumption with two explicit rates. Cash coming in is grown forward to the end of the project at a reinvestment rate, usually the cost of capital, and cash going out is discounted back to today at a finance rate.
The calculation then asks a simple question. Given the amount invested today and the single accumulated value at the end, what constant annual rate connects the two, which is the same idea as a compound growth rate.
MIRR also removes a second problem. Projects with cash flows that switch between negative and positive more than once can mathematically produce several different internal rates of return, whereas MIRR always yields a single answer.
The catch is that MIRR shifts judgement into the chosen rates. Two analysts using reinvestment rates of 6% and 10% will get different answers for the same project, so the rate assumption should be stated openly rather than buried in a spreadsheet cell.
In practice most finance teams report net present value first and use MIRR as a supporting measure. Net present value tells you how much value a project adds in dollars, while MIRR expresses the same project as a percentage that non-specialists find easier to compare.
In practice
Real-world examples
Example 1
An energy company compares two projects with internal rates of return of 22% and 19%. Recalculating on MIRR at an 8% reinvestment rate narrows the gap to 14.1% and 13.6%, and the board chooses the second project because it needs $4,000,000 less capital up front.
Example 2
A property developer models a scheme with an outflow in year one, inflows in years two and three, and a large remediation outflow in year four. The sign changes produce two mathematically valid internal rates of return, so the finance team reports MIRR instead to give the investment committee a single number.
Example 3
A software firm evaluating a $2,000,000 platform rebuild finds an internal rate of return of 31%. Because its spare cash sits in deposits earning 4%, it reports MIRR at that reinvestment rate, and the more modest 18% figure sets realistic expectations with the board.
Think of it
Imagine a marathon runner who drinks water. A standard calculation assumes every sip magically doubles their speed forever. The modified version assumes the water just keeps them hydrated at a normal, steady pace.
Formula
Calculation
MIRR = (future value of positive cash flows at the reinvestment rate / present value of negative cash flows at the finance rate)^(1/n) - 1
A manufacturer invests $500,000 today in a new production line and expects cash inflows of $150,000, $180,000, $200,000 and $220,000 over the next four years. The reinvestment rate is 8% and the only outflow is the initial $500,000, so its present value is $500,000.
Growing each inflow forward to year four at 8% gives $150,000 x 1.08^3 = $188,956.80, $180,000 x 1.08^2 = $209,952.00, $200,000 x 1.08 = $216,000.00, and $220,000 with no growth. Those add to $834,908.80.
The ratio is $834,908.80 / $500,000 = 1.66982, and raising that to the power of 1/4 gives 1.1368. Subtracting 1 leaves a MIRR of about 13.68%.
The ordinary internal rate of return on the same cash flows is roughly 17.19%. The 3.5 percentage point difference is entirely down to the reinvestment assumption, and 13.68% is the honest figure if the company can genuinely only redeploy spare cash at 8%.Case study
Seen in the real world
The following is an illustrative and entirely fictional example. Calderstone Packaging, an invented carton manufacturer, was choosing between two capital projects and had a policy of approving anything above a 15% internal rate of return.
A high-speed cutting line required $500,000 and promised inflows of $150,000, $180,000, $200,000 and $220,000 across four years, an internal rate of return of about 17.19%, comfortably clearing the hurdle. Its cost of capital, and the realistic rate at which it could redeploy the cash generated, was 8%.
In this fictional scenario the finance director recalculated on that basis. The inflows accumulated to $834,908.80 by year four against the $500,000 invested, giving a MIRR of about 13.68%, below the 15% hurdle. The board approved the project anyway, but it also rewrote the hurdle policy to set separate thresholds for the two measures, having realised that its 15% rule had been comparing projects on an assumption the company could not deliver.
Watch out
Common mistakes
- Comparing a MIRR against a hurdle rate that was set for ordinary internal rates of return, which unfairly rejects sound projects.
- Setting the reinvestment rate equal to the project's own return, which simply reproduces the internal rate of return and defeats the purpose.
- Forgetting to discount later outflows at the finance rate, so the denominator understates the true investment in the project.
Questions
People also ask
Why is MIRR usually lower than the internal rate of return?
Because it reinvests cash at a realistic rate rather than at the project's own higher return, which produces a smaller accumulated value at the end.
What reinvestment rate should be used?
Most companies use their weighted average cost of capital, or the actual return available on surplus cash if that is lower and more honest.
Does MIRR replace net present value?
No, net present value remains the primary decision rule because it measures value added in dollars, while MIRR is a percentage that makes projects easier to rank and explain.