Proceedings of the 2014 Industrial and Systems Engineering Research Conference

Y. Guan and H. Liao, eds.

Is the MIRR a Suitable Indicator for Projects with
Multiple Outflows?

Nikolay Yu. Kulakov
The Moscow Institute of Physics and Technology, Moscow, Russia

Anastasia N. Kulakova
The Higher School of Economics, Moscow, Russia

Abstract

Applying the MIRR to evaluate investment projects with multiple outflows is discussed. It has been proved that in the
case when the MIRR is determined by two independent rates (barrier and reinvestment) it fails to characterize the rate
of return. As an alternative to MIRR the Generalized Net Present Value (GNPV) technique recently proposed by
Kulakova and Kulakov is considered. A graphical method of nonconventional project evaluation based on the MIRR
criterion is suggested. Several test projects are demonstrated. Using MIRR method for capital budgeting of such
projects led to a mistake whereas the GNPV method allowed us to arrive at the correct result. The new approach could
justify amendments to the generally accepted theory regarding the MIRR.

Keywords
Modified Internal Rate of Return, Non-Conventional Cash Flows, Capital Budgeting.

1. Introduction.
Inconsistent results of investment project evaluation by the NPV and IRR methods (in case of ranking several mutually
exclusive projects and evaluating nonconventional projects) have inspired many researchers to investigate and develop
a return-based alternative to the IRR. The difference in the results obtained by using both the NPV and the IRR methods
can be accounted for as follows: i) both methods assume an implicit reinvestment of positive interim cash flows which
the project generates; ii) the NPV method implicitly assumes that positive cash flows can be reinvested at a rate equal to
the firms opportunity cost, and the IRR method at a rate equal to the IRR [1-7]. However, the reinvestment
assumption at IRR may distort project returns in case of investments leading to very high or low rates of return. In order
to avoid this misleading assumption, a number of criteria taking account of the reinvestment rate were suggested [7-14].
As a result of generalizing a number of indices, the MIRR was selected and became a classical criterion [8-12].
According to its supporters, the MIRR is preferable to the IRR [9, 15-21].

On the other hand, some researchers object to using the MIRR or other IRR-based alternatives. For example, Ryan
showed that the MIRR depends on the cost of capital but fails to characterize the project [22]. This method cannot be
used to compare projects with different costs of capital [12]. Bernhard noted that alternative rate of return indices and
their associated decision rules, even when correctly used, generally require substantially more computation to yield the
exact same results as those yielded by the net present worth index, and since the magnitudes of any of the rates of return
can be difficult to interpret and hence easily misunderstood, there really seems to be no compellingly good reason for
using the rates of return and their associated procedures at all [23]. However, the IRR does have economic significance
in case of projects with conventional cash flows and is their rate of return or rate of cost [24].

Initially the MIRR method, like the NPV method, used a single rate (i.e. the cost of capital) to calculate both the present
value and the terminal value [8]. Many researchers justify the use of the cost of capital as a reinvestment rate for the
NPV method, assuming that the firm operates in a reasonably competitive industry [16, 25]. At the same time, some
researchers pointed out the main NPV and IRR disadvantage that is using the same discount rate for both finance and
investment cash flows [26]. Lin suggested using different discount rates for finance and investment cash flows [9].
Following this innovation many economists insist on replacing the IRR with the MIRR, especially for conventional
projects with multiple outflows [16, 19, 27].

In this paper we show that the MIRR cannot characterize the rate of return of an investment project whose investment
stage exceeds one period (for details see section 2). In particular, it is demonstrated that in the case of independent
finance (barrier) and reinvestment rates, the MIRR increases as the finance rate increases. It is against all common
sense! In the third section we discuss the recently proposed GNPV method [28] and compare it with the MIRR method
Kulakov and Kulakova


2
(including graphical representation of both methods, i.e. GNPV & MIRR diagram). In section four we discuss the
examples and make a conclusion.

2. Criticism of the MIRR method
Let us consider the MIRR definition formulated by Lin [9].

+ =
N
i
i N
i
r CF FV
0
) 1 (
, if
0 >
i
CF
,
(1)

=
+
=
N
i
i
i
r
CF
PV
0
) 1 (
, if
0 <
i
CF
,
PV
FV
MIRR
N
= + ) 1 (
,

where CF
i
is the projects cash flow at time i (i =0, , N), PV is the present value of negative cash flows, FV is the
future value of positive cash flows, r is the discount rate. The weighted average cost of capital (WACC) is generally
used as a discount rate.
The MIRR decision rule. If MIRR is greater than WACC, accept the project; otherwise, reject the project. For
mutually exclusive projects, accept the project with the highest MIRR.

This rule is a consequence of the NPV rule [9, 23], as the NPV definition is:


+
=

+ + + = + =
N
i
i
i
N
i
i
i
N
i
i
i
r CF r CF r CF r NPV ) 1 ( ) 1 ( ) 1 ( ) (
0
,
(2)
where

i
CF are negative cash flows and
+
i
CF are positive cash flows. Let the NPV function be greater than zero at the
discount rate r (NPV(r) > 0). We have:
+ + > + + > + + +

+ +
N
i
i
i
N
N
i
i
i
N
N
i
i
i
N
i
i
i
r CF r r CF r r CF r CF ) 1 ( ) 1 ( ) 1 ( ) 1 ( 0 ) 1 ( ) 1 (


PV r FV r CF r r CF
N
N
i
i
i
N
N
i
i N
i
) 1 ( ) 1 ( ) 1 ( ) 1 ( + > + + > +

+
.

As:
MIRR r MIRR
PV
FV
r
N N
< + = < + ) 1 ( ) 1 (
.
(3)

Thus, the condition under which MIRR r < follows from the condition 0 ) ( > r NPV and condition under which
MIRR r >

follows from the condition
0 ) ( < r NPV
. Therefore, the MIRR rule does not create any new knowledge in
project appraisal, it is just another representation of the NPV rule. Lin emphasized this quality of the MIRR as an
advantage [9]. On the contrary, Bernhard pointed out that the MIRR can be difficult to interpret and hence easily
misunderstood [23].

Although application of the WACC in the MIRR method has been substantiated by some researches [25], failure to
distinguish between financing (negative) and investment (positive) cash flows is the main drawback of the IRR and
MIRR methods [9, 26, 29]. The drawback can be easily eliminated in the MIRR method. The positive cash flows are
reinvested at the firm's cost of capital p, and the initial outlays are financed at the firm's financing cost r. As a result, the
formula for MIRR is as follows:

+ =
N
i
i N
i
p CF FV
0
) 1 (
, if 0 >
i
CF ,
(4)

=
+
=
N
i
i
i
r
CF
PV
0
) 1 (
, if 0 <
i
CF ,
PV
FV
MIRR
N
= + ) 1 (
.

where CF
i
is the projects cash flow at time i (i =0, , N), PV is the present value of negative cash flows, FV is the
future value of positive cash flows, p is reinvestment rate, r is finance rate.

For the MIRR determined by two rates, the MIRR decision rule is:
Projects with the MIRR greater than the project's finance rate should be accepted; in case of mutually exclusive
projects, the project with a higher MIRR should be preferred.
Kulakov and Kulakova


3

Textbooks tend to recommend the MIRR method for projects whose investment stage does not exceed one period. If
this is not the case the MIRR can be calculated differently [22]. However, in this case the MIRR may yield erroneous
results. Let us prove this suggestion.
According to the formula (4) the future value of the project's cash inflows FV depends on a reinvestment rate p, while
the present value of the project's cash outflows PV depends on a finance rate r. In the case of the independent rates the
finance rate will influence MIRR via the present value of investments. Let us calculate a derivative of the present value
at the finance rate r.
0 , 0
) 1 ( ) 1 (
0
1
0
< <
+
=
|
|
.
|

\
|
+

c
c
=
c
c

=
+
=
i
N
i
i
i
N
i
i
i
CF as
r
iCF
r
CF
r r
PV


If investments are made not only in the initial period (N > 0) the derivative of the present value PV at the finance rate
will be negative. Therefore, the finance rate increase results in decreased present value of cash outflows and increased
the MIRR. Hence, according to the MIRR rule, a higher cost of capital makes the project more effective, which is
against common sense. Therefore, the MIRR determined by two independent rates cannot be an assessment criterion for
projects with investment stages exceeding one period.

3. Alternatives to the MIRR.
The problem of determining a rate of return for non-conventional projects cannot be solved within the bounds of the
NPV method because the NPV method uses a single discount rate [30]. Kulakov and Kulakova [28] have recently
proposed the GNPV method, which allows us to calculate the rate of return for non-conventional projects.
The GNPV function generalizes the NPV function by introducing two discount rates: the internal and the external
one. The GNPV function is determined as follows:
, ) , (
; 0 , . . . , 1 ,
) 1 (
, 0 ,
) 1 (
,
0
1
1
1
PV p r GNPV
N i where CF
p
PV
otherwise V P if CF
r
PV
PV
CF PV
i
i
i i
i
i
N N
=

= +
+
> +
+
=
=
+
+
+

(5)
where: CF
i
, - the projects cash flows at time i, (i = N, , 0),
PV
i
- the projects present value at time i,
r and p are the internal and the external discount rate, respectively.
Thus, the GNPV function is determined by consistently discounting cash flows from the end to the beginning of the
project. If the present value of the project in a certain period is positive, we use the internal discount rate, otherwise
the external one. The internal rate determines the cost of investment, and the external rate determines the return on
investment.

The GNPV(r, p) function has two main properties:
- it decreases monotonically as the internal discount rate r increases and the external discount rate p remains
fixed;
- it increases monotonically as the external discount rate p increases and the internal discount rate r remains
fixed.
Due to these properties we can use the bisection method or Newton's method to find the roots of the equation:

0 ) , ( = p r GNPV . (6)

The solution of this equation can be sought in the form of r = r(p) or p = p(r) depending on the purpose of non-
conventional project evaluation. If we need to evaluate the project as an investment, it is necessary to solve equation (6)
with respect to the internal discount rate r. The solution is the function r(p) which determines a rate of return of an
investment according to the conventional point of view. It represents the maximum interest rate on the loan borrowed to
finance the project, with the resulting income of the current project used to repay the principal amount and the accrued
interest. This rate of return called the Generalized Internal Rate of Return (GIRR) is similar to the internal rate of return
in case of conventional projects.
If a non-conventional project is considered as a loan, i.e. source to finance another project, the equation (6) needs to be
solved with respect to the external discount rate p. The solution is the function p(r) which determines the effective
Kulakov and Kulakova


4
interest rate on the loan. This rate of return is called the Generalized External Rate of Return (GERR). It represents the
minimum rate of return of an external project in which the borrowed funds can be invested to generate sufficient income
to repay the loan with the accrued interest.

Graphical representation of the GNPV method.
The GNPV method has a clear graphical representation, which simplifies project evaluation and ranking. Figure 1
shows a GNPV diagram for a nonconventional project. The blue curve corresponds to the zero GNPV and divides the
plane (r, p) into two regions. The area of the positive GNPV lies above the curve, and the area of the negative GNPV
lies under the curve. Let the finance and reinvestment rates be r and p, respectively, and determine point A(r, p). A
vertical dashed line passing through the point A intersects the blue curve in a point with coordinates (r, GERR). A
horizontal dashed line passing through the point A intersects the blue curve in a point with coordinates (GIRR, p).
There are the GNPV, GIRR, and GERR rules for justifying and ranking independent nonconventional projects. These
rules are easy to apply using the GNPV diagram [28, 31].


Figure 1. The graphical method to find the projects GIRR and GERR.
The decision rules for justifying and ranking independent nonconventional projects based on GNPV diagram:
- The GNPV rule. If the point A (r, p) lies above the line GNPV(r, p) = 0, the project should be accepted,
because GNPV > 0. If the point A (r, p) lies below the line GNPV(r, p) = 0, the project should be rejected,
because GNPV < 0. When evaluating several independent nonconventional projects, accept the project with the
lowest GNPV curve as an investment and the project with the highest GNPV curve as a loan.
- The GIRR rule. If the point GIRR lies to the right of the point r on the X-axis (GIRR > r), the project should
be accepted as an investment; if this condition is not met, the project should be rejected. Among several
projects select the investment project with the rightmost GIRR.
- The GERR rule. If the GERR lies below the line p, p > GERR and the project should be accepted as a loan; if
this condition is not met, the project should be rejected. When evaluating several independent nonconventional
projects, accept the project as a loan with the lowest GERR.
These rules do not contradict each other unlike the NPV and IRR rules.
Kulakov and Kulakova


5

Figure 2. A project assessment by using the GNPV and MIRR diagrams.
The GNPV and MIRR diagrams can be considered as a single graph. Figure 2 represents two curves related to one
project. The solid blue curve corresponds to the equation GNPV(r, p) = 0 and the dashed green curve corresponds to the
equation MIRR(r, p) = r. Let us consider a point on the plane (r, p) corresponding to the finance and reinvestment rates.
If the point lies above the curve MIRR(r, p) = r, the project should be accepted according to the MIRR rule. If the point
lies below the green curve, the project should be rejected.
Let the point A lie inside the area between the two curves. The intersection points correspond to two values of the IRR.
The point A lies below the curve MIRR(r, p) = r, therefore the project should be rejected according to the MIRR rule.
However, the point A lies above the curve GNPV(r, p) = 0, therefore the project should be accepted according to the
GNPV rule. Thus, application of the GNPV and MIRR rules will lead to contradictory conclusions for all the points
located between the curves.

4. Example discussion
Let us consider several projects for which the MIRR rule results in an incorrect decision.

4.1. Recurring deposit
Let us consider a recurring deposit as an example of a project with repeated investments. The investor deposits a fixed
amount at a certain interest rate on a regular basis. At the end of the tenure, he gets a lump sum which is equal to the
total amount of the investments made plus the compound interest earned on them. Suppose an investor made a quarterly
investment of $10,000 and received a $42,301 return at the end of the year. The cash flows of this recurring deposit are
shown in table 1. The rate of return of the deposit is 9% per year. Suppose the investor borrowed the deposited amounts
and the available interest rates were 6%, 8% or 10%. Which loan should the investor choose?

Table 1: A recurring deposit with multiple outflows.
Tenure 0 1 2 3 4 Return IRR
Cash flows -10 000 -10 000 -10 000 -10 000 42 301 2 301 9%
Table 2 lists the capital budgeting indices for the three options of the interest rate. According to the NPV rule we should
accept option 1, which has the highest NPV. According to the MIRR rule we should accept option 2. Option 3 is
rejected, since MIRR(10%) is lower than 10%. Thus, formal application of the MIRR rule may lead to incorrect
decision on project financing.
Table 2: The values of the indices.

R % Return FV PV IRR NPV MIRR
Option 1 6% -1 523 778 42 301 -39 122 9% 734 7,89%
Option 2 8% -2 040 261 42 301 -38 839 9% 241 8,63%
Option 3 10% -2 563 -262 42 301 -38 560 9% -237 9,37%

4.2. Non-conventional project
Let us consider a nonconventional project in which investments are made at the initial and final stages [31].

Kulakov and Kulakova


6
Table 3: Cash flows of a housing construction project with shared investment.
Period 0 1 2 3
Cash flows -100 75 150 -100

The NPV function of this project decreases as discount rate increases for range r > 0, IRR = 31,4%. But the project is
nonconventional therefore it is impossible to use the IRR rule. Let us follow the recommendations of financial
textbooks and apply the MIRR rule. If the finance rate is 23% and the reinvestment rate is 15%, we get the MIRR (23%,
15%) =20.9%. The MIRR is lower than the finance rate therefore the project should be rejected according to the MIRR
rule. But this decision is wrong. Let us review the cash flow statement of the project (Table 4). The initial investment is
financed by a loan at 23% interest rate. The income of the 1-st period is spent on interest payment and partial repayment
of the principal amount. The net yield after all payments of the second period (91) is deposited in a savings account at
15%. The net balance of the project is positive.

Table 4: Cash flow statement of the construction project.
Period 0 1 2 3
Starting cash 0 0 0 0
Operating 0 -23 -11 0
Interest payments 0 -23 -11 0
Investing -100 75 59 4.6
Cash paid to construct buildings -100 -100 -100 -100
Cash received from sale of buildings 0 175 250 0
Cash deposited in a bank account (reinvestment) 0 0 -91 0
Cash received from deposit with interest 0 0 0 104.6
Financing 100 -52 -48 0
Loan obtained 100 0 0 0
Loan repayment 0 -52 -48 0
Bottom line 0 0 0 4.6

The finance rate resulting in zero net balance is called the GIRR. It amounts to 25.3% on condition that the
reinvestment rate is 15%. As the GIRR exceeds the finance rate (25.3% > 23%) the project should be accepted.


Figure 3: The project should be accepted according to the GNPV rule
and should be rejected according to the MIRR rule.

Let us use a graphical representation of the GNPV and MIRR methods to evaluate the project (Figure 3). The point A(r,
p) corresponding to market environment (r = 23% and p = 15%) lies above the curve GNPV(r, p) = 0 and below the
curve MIRR(r, p) = r. Therefore, the project should be accepted according to the GNPV rule, but rejected according to
the MIRR rule. This is another proof of the fact that the MIRR rule can lead to a wrong decision for projects with
multiple outflows.

5. Conclusion
Kulakov and Kulakova


7
The IRR is known to provide a meaningful interpretation of a rate of return for conventional investment projects, while
being contradictory for nonconventional projects. A lot of attempts to define a rate of return for nonconventional
projects in terms of the NPV approach failed to elicit a reliable method of evaluation. Numerous indices have been
developed to replace the IRR for nonconventional projects and the MIRR was generally approved and eventually
became a classical criterion. Based on only one rate, the MIRR rule results from the NPV rule, without the latters
economic significance. The MIRR was improved by using two different rates for inflows and outflows. Currently, it has
become the main alternative to a rate of return for nonconventional projects.
This paper has attempted to show that using the MIRR to make decision on projects with multiple cash outflows could
lead to erroneous results. We have proved the MIRR increases along with the finance rate.

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