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In capital budgeting, the IRR implicitly assumes reinvestments of interim cash flows at the IRR itself....

In capital budgeting, the IRR implicitly assumes reinvestments of interim cash flows at the IRR itself. First, discuss why this assumption is problematic. Then, explain how MIRR address this issue by presenting your own unique example with proper calcuations. The example project should be a 4 year project. For example, a 4-year project with following cash flows, -500, 200, 200, 200, 100, at T=0 to 4, respectively.

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Answer #1

IRR rate is higher than WACC generally so reinvestment as higher than WACC may not be possible always in real world.MIRR assumes reinvestiment at discount rate which is lower than IRR

Example Cash flows =-1287.8350. 150,182,380,430
Reinvestment Rate =10%
Cost of capital =14.36%

FV of cash inflows =150*(1+10%)^4+182*(1+10%)^2+380*(1+10%)^1+430=1287.8350
MIRR =(FV of Cash inflows/PV of Cash outflow)^(1/n)-1
PV of Cash outflows =FV of Cash inflow/(1+MIRR)^n=1287.8350/(1+14.36%)^5 =658.3995

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