Internal Rate of Return Modified Internal Rate of

Internal Rate of Return & Modified Internal Rate of Return PWC Course Notes P 53 Mark Fielding- Pritchard mefielding. com 1

Advantages and Disadvantages of the IRR Advantages Disadvantages % so people feel they understand it % so 20% of $1 is better than 15% of $1 m Rate of return How to benchmark Relatively easy to calculate Multiple IRRs Widely accepted No need to pick a discount rate mefielding. com 2

Internal Rate of Return We have a potential coal mining project in Scotland. There will be an initial investment in purchase of land, licenses, equipment. We can harvest coal from the surface so the NPV quickly becomes positive. Once exhausted we must dig down to the next seam which requires expenditure so the NPV becomes negative, once mining resumes we receive sales and he NPV becomes positive mefielding. com Net Present Values Year 1 -20 Year 2 2. 5 Year 3 -6 Year 4 4. 5 Year 5 12 3

Internal Rate of Return Mining Project 15 12 10 5 4, 5 Net Present Value 2, 5 0 Year 1 -5 Year 2 Year 3 Year 4 Year 5 -6 -10 -15 -20 mefielding. com -25 -20 Time 4

Modified IRR Used to counter the fact that we get multiple IRRs Year Net after tax cash flow $ 0 -20 1 7 2 -3 3 12 4 10 Company uses discount rate of 10% Note that for exam purposes we are looking here at cash flows, not NPV mefielding. com 5

MIRR What we are doing is smoothing the cash flows so that we don’t get multiple IRRS. We make 2 assumptions - All expenses (negative numbers) occur at time 0 - All income (positives) occur at time 4 - Discount rate 10% Year Net after tax cash flow $ 0 -20 1 7 2 -3 3 12 12 x 1. 1= 13. 2 4 4 4 Total mefielding. com Inflow Outflow 20 7 x(1+0. 1)³ = 9. 32 26. 52 22. 48 6

MIRR mefielding. com 7