IRR v. MIRR Valuation Methods
Determining the IRR involves a few mathematical equations in order to see what a projected outcome for say a year would be. The equation for determining IRR is -
(Future value)/(1 + interest rate)^n
The future value would be the amount of profit that a company or business would receive based on the investment and the exponential of 'n' represents the number of years or length of time that is projected for the value of the project or item.
The IRR is a very popular method in determining capitol budgeting that is used by many businesses; however, it also has many flaws that skew a company's projected numbers. The biggest problem is that it does not take into account the risk factors or other costs that could come from a company's return. This is where the MIRR comes in.
What MIRR does is fill in the limitations that come from the IRR. As seen in the picture above, the calculation for the MIRR combines both future value and that of the present value, allowing for finance rates and money flowing out of the business.
In terms of IRR v. MIRR valuation methods, MIRR is the better choice as it gives a much clearer view on what a company stands to either gain or lose in terms of an upcoming project or purchase. The IRR is more of an optimistic view of returns, while the MIRR is a realistic view. This does not mean that the IRR is obsolete or it cannot be used. In fact, using both in conjecture with a project could be beneficial, as long as you compare and contrast both results.
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