CONCURRENT EVALUATION- 2

TREASURY MANAGEMENT

Submitted by:Name- RAJAT MEHTA

Roll no. - 98 (B)

 Internal Rate of Return (IRR)

The Internal rate of return (IRR) for an investment is the percentage rate earned on each
dollar invested for each period it is invested. IRR is also another term people use for interest.
Ultimately, IRR gives an investor the means to compare alternative investments based on their
yield. (propertymetrics)

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)

The internal rate of return (IRR) of a project is a discounted rate which

makes it NPV equal to zero. Put differently, it is the discounted rate which
equates the present value of future cash flow with the initial investment.
(Chandra, 2010)
Internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability
of potential investments. Internal rate of return is a discount rate that makes the net present value
(NPV) of all cash flows from a particular project equal to zero. (investopedia)

Example:A company has to consider the following project:

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

NPV of the proposal

67

-235

IRR may be founded by interpolation between 10% and 11% as follow:

IRR= lower discount rate +

PV of cash inflow of Xintial investment

PV of cash inflow of X PV of cash inflow of y (higher discount
rate - lower discount rate)

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.

Modified Internal Rate of Return (MIRR)

Modified internal rate of return (MIRR) assumes that positive cash flows are reinvested

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.

If an investment project is described by the sequence of cash flows:

Year

Cash flow

-1000

-4000

5000

2000

then the IRR r is given by

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):

PV (Negative cash flows, finance rate) = -1000+

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

Third, we find the MIRR:

MIRR =

FV ( positive cash flow , reinvest rate)

pv( nehative cash flow , finance rate)

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

 INVESTOPEDIA. (n.d.). Retrieved 08 25, 2016, from INVESTOPEDIA:

http://www.investopedia.com/terms/m/mirr.asp
Modified rate of return. (n.d.). Retrieved 08 25, 2016, from Xplain:
http://xplaind.com/882858/modified-internal-rate-of-return
Pandey, I. M. (2005). Financial Management. In I. M. Pandey, Financial Management
(p. 787). New Delhi: Vikas Publication house pvt ltd.
PANDEY, I. M. (2005). Financial management. In I. M. PANDEY, Financial
management (p. 787). New Delhi: Vikas publishinhg house pvt ltd .
propertymetrics. (n.d.). Retrieved 08 25, 2016, from propertymetrics:
http://www.propertymetrics.com/blog/2014/06/09/what-is-irr