ADJUSTMENT OF MODIFIED INTERNAL RATE OF RETURN FOR SCALE AND TIME SPAN DIFFERENCES

The use of the Internal Rate of Return (IRR) method of cap ital budgeting is popular as many managers prefer a rate of return method as a decision-making criterion for capital budgeting. However, the Net Present Value (NPV) method is preferred by academics since the rankings of mutually exclusive projects by IRR may not always select the project which will maximize the value of the firm , due to an implied reinvestment rate assumption by IRR. In response to this weakness, the Modified Internal Rate of Return (MIRR) was developed. However, MIRR may also lead t o erroneous rankings when projects require different initial outflows to start the project, the scale problem, or th e projects have different lives, the time span problem. This paper demonstrates how MIRR can be adjusted to giv e rankings that are consistent with NPV for projects in the same risk class, even with scale differences and for som e types of time span differences. A secondary contribution is a simplified method of computing MIRR with examples to show the consistency with the NPV and with the goal of maximizing the value of the firm to its shareholders.