IRR vs MIRR - The Problem With IRR Explained
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- Опубликовано: 12 июл 2024
- In this video, I explain the difference between IRR & MIRR and walk through several examples applying the two concepts.
What is MIRR? How is it used to judge capital projects? A study completed by McKinsey identified the key weakness of using IRR as an indicator of strength for capital projects. The reinvestment assumption assumes that any interim cash flows from the project will be reinvested at the same IRR throughout the investment period, an assumption truly flawed. By using MIRR, analysts are better able to judge a project's true value by reinvesting interim cash flows at the company's cost of capital.
Read the full report at:
www.mckinsey.com/business-func...
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finally .. this is the best explaination of MIRR vs IRR .. thanks
Truly the best explanation I could find on youtube. Thank you man!
I was really struggling to know about MIRR .Thanks a lot for such explanations ,my confusion are cleared out.
Best explanation you can find in youtube about the difference between IRR and MIRR.
I can easily tout this video as one of the best available to understand IRR and MIRR!
I was struggling to understand the reinvestment assumption with irr, but your video cleared all my confusions.
Finally, I can understand what MIRR is and how to calculate it. Many thanks!
Bro, i bet you are the best finance prof. Ever!! Please keep up your work! People love you. Wishing you all the success.
Brilliant! Thank you so much for the great examples and explanations!
It is an interesting example to understand about IRR
Thank you !
fantastic work @financekid!
Thank you, I'm going to share this with my classmates!
Very helpful! Thanks for the clear explanation!
Very good explanation. Thank you!
Great explanation of IRR and MIRR and their differences and shortcomings! Still don't understand why most real estate offering only show IRR. I guess it's just the buzzword, most passive investors can barely even understand IRR, let alone it's shortcomings :-)
Life saver! Thank you for this video! Most helpful!
Beautifully explained
Great explanation , thanks !
Great effort man
thanks for this video
Awesome explanation, thanks
Brilliant video, thank you
Thanks for much needed clarification..
Great video really helpful!
Great Video!
ThankYou so much for this amazing video
Thanks for watching!
Beautiful Explanation
Thank you!
Hey great video!!! But can you please elaborate on "differences in duration impact the importance of a higher or a lower irr explain"
Very informative
Thank you so much !
Great video
Helpful!
What happens if say the cash inflow of the project in say year 2 or at the end of the project life cycle is negative. Would you still find the terminal value or would you the figure and total it with the PV of outflow figure for the equation at the end of the MIRR?
This helps a lot. However, I have an issue with claim (here and just about every other related article / video) that the IRR approach assumes the IRR will be used for the accumulation of interest going forward regarding cash inflows. There is no such assumption in the calculation of the IRR. The issue is with people misusing the IRR in this manner, i.e., to calculate further returns.
Brother do you get any clarity over this question. Because I'm having the same issue . If you have any clarity over this part could you explain. Please?
It is an automatic assumption, if it is the calculated discount rate it only makes sense to use it as a compounding rate going forward. Maybe that kinda helped you.
Its natural that the compounding is bound to happen about accumulated interest and thereby it's an inherent assumption that IRR will give you the result keeping the base that PV will be equal to you investment ad those cash inflows are used to compound over time.
This is my exact problem. There is no reinvestment going on at all. Do they mean the cash flows we are generating in subsequent years already have the return on reinvestment incorporated in it? Essentially saying cash inflow in a year is the sum of what the project will earn AND the interest earned on reinvestment of cash flows?
Great video. In your example, what should we do if suddenly there is an outflow in year 6?
I think you need to discount it back to year0. So, all outflows on left hand side, irrespective of when they actually incur.
At 10:30, don't you mean projecting cash inflows (the green area) at the cost of capital? Excellent lecture btw!!
Isnt the IRR inversely proportional to the amount of capital? (because more capital requires more profits to support the same IRR), so doesnt IRR go down when capital goes up? @17:17
Is excel formula for mirr correct ?... thanks.
if a company has evaluated 3 investment proposals under IRR method, yielding different rates of return. Though the IRR values are varying, will the reinvestment rate of intermediate cash inflows is assumed to be the same for all these 3 proposals?.
Marvelous
in the graph you showed....Why does IRR increase when you increase the cost of capital? Cost of capital is an input in MIRR, so that increasing i understand, but why does IRR go up, it has nothing to do with cost of capital?
It seems like not even him knows the answer
Exactly the same thing
thank you for the explanation. could you please explain why the reinvesting rate equals the financing rate in the second example? i mean the example where both equal the cost of capital which is 7.5%
It just says the difference between project a and project b is the key assumption. Key assumption for A was that reinvestment rate was at IRR. Key assumption for B was that reinvestment rate was instead at the company cost of capital.
Thank u sir
IRR and NPV can conflict, but can MIRR and NPV conflict? ex. can project A have higher NPV but lower MIRR than project B?
So just to confirm in case of MIRR we are investing and reinvesting at Cost of Capital rate?
I thought that the present value of expected future cash flows landed one period before. So in year one, you wouldn’t need to discount because the pv is at t=0. I am likely wrong, but want clarification.
In finance modelling, "today" is year zero. So, if you have a cash flow in year 1, you have to discount it to year zero. "Year 0" would be, for example, 01/01/2020 and "year one" would be 01/01/2021. That's why you don't discount the investment (you wouldn't earn any money for lending $100 right now to someone and getting your money back in the same moment), but you do discount the cash flow from year 1 (you would earn some interest if you lend $100 right now and get it back a year ahead from now). I don't know if that answers your question or if it makes any sense.
Also, can’t you find the MIRR without writing it out by doing this:
NPV=PV(future cashflows)-outlay
NPV+outlay=PV(FCFs)
PV(fcfs)*(1+r)^n=FV or TV
And then plug it in? Again? correct me if I’m wrong
NPV gives dollar values not rate of return.
In the MIRR case why in year 1 fv = 544.20, it is 400*1.08=432
in 11:55 when i find the FV of the 400, i get 587.73. how do you find the FV of 400?
400$ are invested for remaining 4 years at 8% i.e.
FV=PV(1+r)^n
FV=400(1+0.8)^4=544.20
I Hope you understood😊
Thank you for the video. Could you please explain why does the IRR increase when the cost of capital increases? For MIRR it is pretty clear, for IRR not that clear.
I also have this question.
short answer is the Cash flows are going to be greater hence higher IRR when using that method.@@chrisfreeman7423
you are awesome
Why does IRR change in the graphs with Cost of capital? MIRR would increase because cash collected can be invested at a higher rate, increasing the MIRR. But Is IRR not supposed to be the same, whatever be the cost of capital?
Bc future cash outflows are worth less today depending on the cost of financing. The higher the cost, the less the NPV. Only applies to cases when there are neg CFs in a year different to 0.
@@diegofernb But does IRR depend on cost of finance?
@@kunalkiran3318 I'd tend to think that IRR treats outflows the same way as inflows. It assumes these are financed at a same rate. So it makes no distinction, unlike MIRR that lets you input different financing and reinvestment rates. I'm guessing here, the concept is still esoteric to me
In the reinvestment rate example, how did you arrive at $10 million investment = $56 million?? The actual cash flows are already defined, at $5 million each year, which totals $25 million in the end. If you take the $5 million in each year and discount it backwards to present value, there would be an assumption that it grows for 5 years, reinvested at the IRR. But instead you're taking each cash flow and discounting it forward, which doesn't seem right. I'm sure i'm wrong though, what am i missing?
No worries, most people get confused. In that example, similar to the one at 1:45 the cash flows from the project are reinvested at the IRR rate for the remaining years of the investment. So 5 million invested for 4 years compounded at 41% annually is 19.7 or about 20 million. Same thing for the next 3 cash flows. The sum of those compounded cash flows at 41% is the 56 million. What the IRR formula does is find that growth rate of 41%. You cant know what that growth rate is without calculating IRR. The whole video is centered on how the formula itself is flawed if you analyze projects with intermediate cash flows. Making the assumption that it can be reinvested at the same rate of return assumes that market conditions will not change.
You Saved my 16 Marks in Exam .. Thanks
Can you please help me in mine? :D
At 16:13, IRR is 25.43%.
Agree. I've been looking in comments to see if anyone else spotted this. He took the IRR of the PV values and not the original values.
The graph on the next slide corrects it by showing IRR at 25.43.. haha but yes, maybe he wanted to test the true curiosity of his audience@@UCLASeraph @AntsNYC
isnt it 400$ already the future value
why mirr used what it does
papers.ssrn.com/sol3/papers.cfm?abstract_id=2942456
Modified IRR (MIRR) Is a Spurious Criterion and Should Not Be Used in Cost-Benefit Analysis (CBA) and Investment Analysis
Kannapiran Arjunan
Abstract
This paper evaluates whether MIRR is an appropriate criterion for investment decision and the true annual rate of return on capital. Unlike other published papers, the present analysis introduces three important improvements viz. the investment returns are consistent with NCF (NCF-consistent); the two components of returns on capital investment, i.e. return of capital invested (ROC) and return on invested capital (ROIC), are clearly defined and accounted for; and finally, capital amortization schedule (CAS) is used to verify whether the returns are achievable from the NCF generated and therefore NCF-consistent. The appropriateness of MIRR is evaluated using numerical analysis and the main findings are:
a. The estimation of MIRR, manually or in excel, is based on the modified net cash flow (MNCF). The MNCF, derived by mathematically adjusting the actual net cash flow (NCF), distorts the intrinsic value of the cash inflow and its timing. With MNCF, the MIRR is lower than the IRR because MIRR failed to fully utilize the NCF generated as shown by the CAS. MNCF is neither NCF-consistent nor accounting concept-consistent (cash vs accrual concept).
b. The problem of reinvestment of intermediate income is a fallacy and therefore the MNCF is a meaningless exercise. For the same NCF, the net benefit stream, MIRR is increasing without any limit with increasing investment rates (IR). The NCF is not adequate to support such an increase in MIRR, as revealed by the CAS. Similarly, when the actual IRR is lower than the IR used, the estimated MIRR is higher than the IRR. Again, the NCF is not sufficient to achieve that higher MIRR than the IRR as confirmed by the CAS. This is one of the serious problems with MIRR that is based on the MNCF, a mere data mining exercise. MIRR is not an accurate estimate but a spurious one.
c. Again, the problem of multiple IRR is a data problem associated with non-normal NCF. MIRR does not solve this problem either. With non-normal NCF, the cumulative sum of undiscounted NCF is zero or negative or negligible. In those cases, the NCF data leads to multiple IRR. The non-normal MNCF leads to spurious MIRR estimate (also GIRR and AIRR) that is not supported by the actual NCF as revealed by the CAS. Any rate of return must be NCF-consistent.
d. With normal NCF also, the MIRR is spurious because of the false reinvestment assumption and the use of MNCF data. The estimated MIRR, based on assumed reinvestment rate, leads to serious problems as explained above. MIRR (when MIRR < IRR) estimate does not fully utilize the benefit stream and leave a closing balance, as revealed by the CAS. Contrarily, IRR fully utilizes the NCF and therefore IRR is higher than the MIRR (paid-off the ROC and ROIC = IRR). When MIRR is higher than the IRR, the NCF does not support that level of MIRR.
e. The results of CAS reveal that MIRR is neither the true return nor the annual rate of return. IRR is also not the annual rate of return but it is the true rate of return on the capital remains invested. Both the MNCF and MIRR are not NCF-consistent but may be mathematically-consistent. When there is no intermediate income, the question of reinvestment does not arise. With that type of NCF, the MNCF and the MIRR are NCF-consistent.
f. Generalized IRR (GIRR) and Average IRR (AIRR) criteria are also reviewed. They are not NCF-consistent but mathematically generated returns and are based on wrong assumptions (reinvestment).
Based on these results, it is evident that the MIRR is a spurious criterion. Investment analysts and decisions makers may wish to move away from using or reporting MIRR as a criterion so also the authors of all published works and finance and economic texts.
99,000of''
This is so wrong.
Why
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