Thai VI

While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm's cost of capital. Therefore, MIRR more accurately reflects the profitability of a project.  
 
For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

NPV = 0 = -195 + 121/(1+ IRR) + 131/(1 + IRR)2        NPV = 0 when IRR = 18.66%

Solving for NPV using MIRR, we will replace the IRR with our MIRR = cost of capital of 12% :

NPV = -195 + 121/(1+ .12) + 131/(1 + .12)2        NPV =  17.47 when MIRR = 12%

Thus, using the IRR could result in a positive NPV (good project), but it could turn out to be a bad project (NPV is negative) if the MIRR were used. As a result, using MIRR versus IRR better reflects the value of a project.