BUS 650- Final Paper - IRR v. MIRR Valuation Methods Erin...

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IRR v. MIRR Valuation MethodsErinKellyJuly 30, 2012Bus 650 Managerial FinanceKristi Rayford
Over the past several years Internal Rate of Return (IRR) and Net Present Value(NPV) are the most important methods, which are used for the capital budgeting decision.These methods were designed to deal with the investment problems of the organizationsand individuals. The periodic cash flows are used to make the investment decision. Inevaluating the financial attractiveness of the projects with NPV and IRR also providesdifferent results. It causes the problem for the organization when capital budget arelimited (Eagle, Kiefer & Grinder, 2008). But there are some problems in these methods,which caused the emergence of the Modified Internal Rate of Return (MIRR) method forthe investment problems.IRR method assumes that the reinvestment is made on the IRR basis, which is notrealistic. On the same time a project may have several IRR as the cash flow from theproject may go positive and negative. In order to solve the problem of positive andnegative cash flows the MIRR method was discovered in 18th century. "The MIRRmethod provides more accurate results for the capital budgeting decisions". The researchpaper describes the problems with the IRR and MIRR method and gives a clear picturethat MIRR method of capital evaluation is better than the IRR method of capitalbudgeting. This research paper also explains that MIRR is helpful to deal with theproblems of other methods of capital budgeting or investment problems.The researchpaper also describes the use of MIRR over IRR as it is helpful to provide more effectivecapital budgeting analysis. It is because; this method is useful for the projects in whichcash flows change significantly or for the mutually exclusive projects (Eagle, Kiefer &Grinder, 2008). The project, which has different lives, should also use the MIRR. But atthe same time there are some issues in MIRR, as it should be abandoned in making
investment decision for individual projects.Internal Rate of ReturnIRR is also an important discounted cash flow method forthe appraisal of capital budgeting proposals. The Internal Rate of Return is the rate,where present value of cash inflows and outflows comes out to be equal or the rate atwhich NPV from the project comes equal to zero. At this rate, there are no benefits orlosses for the Organization. If the Organization earns an IRR on the investment, the NPVwill be equal to zero for the investment. It also helps the Management to take a decisionregarding investment as to whether they should invest in project or not. A higher IRRmakes the project desirable to be undertaken. It provides information about the efficiencyof the project because it is based on the assumption that all the cash inflows are investedagain in the project at the IRR basis (Brigham & Ehrhardt, 2007). This method is alsovery difficult to understand and the assumption for reinvesting money is not appropriate.

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