Question

3. Assume that we are analyzing a positive net present value project. For this project, which measure would be a more conservative measure of the rate of the return – the internal rate of return or the modified internal rate of return?

Answer 1

IRR :
IRR is the Rate at which PV of Cash Inflows are equal to PV of Cash Outflows. It assumes that intermediary Cfs are reinvested at IRR only.

IRR = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in disc rate ] * 1%

If IRR > Cost of Capital - Project can be accepted
IRR = Cost of Capital - Indifferebce Point - Project will be accepted / Rejected
IRR < Cost of Capital - Project will be erejected

Modified IRR:

It is similar to IRR. In IRR, we are assumed that intermediary cashflows are reinvested at IRR only. In MIRR, we assume that Intermediary CFs are reinvested at Reinvestment Rate rather than at IRR.

Thus MIRR is More conservative Rate of Ret to evalauate NPV.