Corporate Finance Quiz: Modified Irr Mirr
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Modified Irr MirrQuestion 1 of 20

A project requires an initial investment of $100,000 and generates cash flows of $40,000, $50,000, and $60,000 in years 1, 2, and 3, respectively. The company's cost of capital is 12%, and the reinvestment rate for positive cash flows is 10%. What is the primary reason why MIRR would be preferred over traditional IRR for evaluating this project?

MIRR eliminates the multiple IRR problem that occurs when cash flows change sign more than once during the project life
MIRR uses more realistic reinvestment assumptions by allowing different rates for financing costs and reinvestment opportunities
MIRR automatically adjusts for project risk by incorporating a risk premium into the discount rate calculation
MIRR provides a higher rate of return than IRR, making projects appear more attractive to investors
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Corporate Finance Quiz

Corporate Finance Quiz: Modified Irr Mirr

Practice Modified Irr Mirr in Corporate Finance with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Modified Irr Mirr, giving you a quick way to practice the rules, question types, and explanations that matter most for Corporate Finance.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

A project requires an initial investment of $100,000 and generates cash flows of $40,000, $50,000, and $60,000 in years 1, 2, and 3, respectively. The company's cost of capital is 12%, and the reinvestment rate for positive cash flows is 10%. What is the primary reason why MIRR would be preferred over traditional IRR for evaluating this project?

  1. MIRR eliminates the multiple IRR problem that occurs when cash flows change sign more than once during the project life
  2. MIRR uses more realistic reinvestment assumptions by allowing different rates for financing costs and reinvestment opportunities (correct answer)
  3. MIRR automatically adjusts for project risk by incorporating a risk premium into the discount rate calculation
  4. MIRR provides a higher rate of return than IRR, making projects appear more attractive to investors
Explanation: MIRR's primary advantage is that it uses more realistic reinvestment assumptions. Traditional IRR assumes cash flows are reinvested at the IRR rate itself, which is often unrealistic. MIRR allows for separate rates: the cost of capital for financing negative flows and a reinvestment rate for positive flows. Choice A is incorrect because this project has conventional cash flows (negative followed by positive), so multiple IRR is not an issue. Choice C is wrong as MIRR doesn't automatically adjust for risk. Choice D is incorrect because MIRR typically yields a lower rate than IRR and the goal isn't to make projects appear more attractive.

Question 2

A CFO is concerned about liquidity and primarily uses the payback period to evaluate projects. An analyst suggests that MIRR should also be considered. What is the primary advantage of using MIRR over the simple payback period?

  1. MIRR is easier to calculate and more intuitive to explain to non-financial stakeholders.
  2. MIRR and the payback period will always rank mutually exclusive projects in the same order of preference.
  3. MIRR provides a direct measure of a project's liquidity and risk, which the payback period only approximates.
  4. MIRR accounts for the time value of money and considers all of a project's expected cash flows. (correct answer)
Explanation: This question tests your understanding of capital budgeting methods and their fundamental differences. When evaluating investment projects, CFOs need tools that provide comprehensive financial analysis, not just partial measures. MIRR (Modified Internal Rate of Return) addresses two critical limitations that make it superior to the payback period. First, MIRR incorporates the time value of money by discounting future cash flows, recognizing that a dollar received today is worth more than a dollar received in the future. Second, MIRR considers the project's entire cash flow stream throughout its life, including both the initial investment recovery and subsequent profitable returns. This gives you a complete picture of the project's financial performance. Looking at the incorrect options: Choice A is backwards – MIRR involves complex calculations with reinvestment assumptions and discount rates, making it harder to explain than the straightforward payback period. Choice B is false because these methods often rank projects differently since they measure completely different things. Choice C mischaracterizes both methods – MIRR doesn't directly measure liquidity or risk, and the payback period doesn't approximate these factors either. The payback period only tells you how quickly you'll recover your initial investment, ignoring what happens afterward and treating all cash flows as equally valuable regardless of timing. MIRR, conversely, provides a comprehensive return measure that accounts for the project's complete financial impact over time. Study tip: Remember that modern capital budgeting methods (NPV, IRR, MIRR) always incorporate time value of money and consider all cash flows, while simpler methods (payback, accounting rate of return) have significant analytical limitations.

Question 3

A firm is evaluating a conventional project where the cost of capital is 10% and the project's IRR is 15%. An analyst correctly states that the project's MIRR must be between 10% and 15%. This conclusion is valid only if the firm uses...

  1. the 15% IRR as its reinvestment rate.
  2. the 10% cost of capital as its reinvestment rate. (correct answer)
  3. a reinvestment rate lower than the 10% cost of capital.
  4. a financing rate that is higher than the reinvestment rate.
Explanation: IRR assumes reinvestment at the IRR (15%). MIRR uses an explicit reinvestment rate. If the firm uses its cost of capital (10%) as the reinvestment rate, this rate is lower than the IRR's implicit assumption. Therefore, the MIRR will be 'pulled down' from the IRR (15%) toward the reinvestment rate (10%), resulting in a value between the two. For a positive NPV project, the MIRR will be above the cost of capital.

Question 4

A company analyzes a project with a large initial outlay and a required negative cash flow for decommissioning at the end of its life. Its after-tax cost of debt is 6% and its WACC is 10%. Initially, the MIRR is calculated using 6% as the financing rate. If the company changes its policy and uses the higher 10% WACC as the financing rate, what will be the impact on the calculated MIRR?

  1. The MIRR will increase, because the higher discount rate reduces the present value of the future decommissioning cost. (correct answer)
  2. The MIRR will decrease, because the higher financing rate makes the future decommissioning cost more burdensome.
  3. The MIRR will remain unchanged, as the financing rate only affects the terminal value of inflows, not outflows.
  4. The MIRR will decrease, because the present value of the decommissioning cost increases with a higher discount rate.
Explanation: The MIRR is calculated as (Terminal Value / PV of Outflows)^(1/n) - 1. The PV of Outflows includes the initial investment plus the present value of any future outflows (like decommissioning costs). Increasing the financing rate (the discount rate for future outflows) from 6% to 10% will decrease the present value of the future decommissioning cost. This makes the denominator (PV of Outflows) smaller, which in turn makes the overall fraction larger, resulting in a higher MIRR.

Question 5

A mining project has the following expected net cash flows: an initial outlay of $500,000, positive inflows for three years, and a significant final-year cost of $200,000 for site reclamation. Why is MIRR considered a more reliable decision indicator for this project than the standard IRR?

  1. MIRR discounts all cash outflows at the reinvestment rate, providing a more conservative project valuation.
  2. The project's non-conventional cash flow pattern (multiple sign changes) is likely to produce multiple IRRs, an issue that MIRR resolves. (correct answer)
  3. MIRR will always be lower than the IRR for projects with a final-period negative cash flow, ensuring a safer decision.
  4. The standard IRR method cannot mathematically process negative cash flows that occur after the initial investment.
Explanation: Projects with non-conventional cash flows (i.e., more than one change in the sign of the cash flow stream) can yield multiple IRRs or no real IRR, making the IRR rule ambiguous or unusable. MIRR avoids this problem by discounting all outflows to time 0 at a specified financing rate and compounding all inflows to the terminal year at a specified reinvestment rate, which guarantees a single, unique rate of return.

Question 6

An analyst is calculating the MIRR for a project with conventional cash flows. The firm's reinvestment rate is currently lower than the project's calculated IRR. If the firm revises its reinvestment rate upward, but the rate remains below the IRR, what will be the effect on the calculated MIRR?

  1. The MIRR will decrease, moving further away from the IRR.
  2. The MIRR will remain unchanged because it is primarily driven by the project's unique cash flows.
  3. The MIRR will increase, moving closer to the IRR. (correct answer)
  4. The MIRR will increase, but the gap between MIRR and IRR will widen.
Explanation: The MIRR calculation compounds positive cash flows forward at the reinvestment rate. A higher reinvestment rate leads to a higher terminal value, which in turn results in a higher MIRR. When the reinvestment rate is lower than the IRR, the MIRR will also be lower than the IRR. As the reinvestment rate increases towards the IRR, the MIRR will also increase and move closer to the IRR.

Question 7

A company is comparing a small, high-return project (Project S) with a large, moderate-return project (Project L). Project S has a MIRR of 25%, while Project L has a MIRR of 18%. The firm's cost of capital is 12%. An analyst correctly calculates that Project L has a much higher NPV. Why might MIRR provide a misleading signal for choosing between these two projects?

  1. MIRR systematically penalizes larger projects by discounting their larger cash flows more heavily than smaller ones.
  2. The MIRR formula does not properly account for the time value of money when the scale of projects differs significantly.
  3. As a percentage return, MIRR does not reflect the magnitude of the value created, which is better captured by NPV. (correct answer)
  4. The reinvestment rate assumption embedded in the MIRR calculation is known to be less valid for larger projects.
Explanation: This scenario describes the 'scale problem'. MIRR, like IRR, is a rate of return and does not account for the size of the investment. A high percentage return on a small investment (Project S) can result in fewer dollars of value created than a moderate percentage return on a much larger investment (Project L). NPV, which measures the absolute dollar value added, correctly captures this difference in scale and is the preferred metric for resolving such conflicts.

Question 8

A project has the following cash flow stream: Year 0: -1,600,Year1:+1,600, Year 1: +10,000, Year 2: -$10,000. This project has two IRRs, 25% and 400%. The firm's cost of capital is 10%. What is the most appropriate conclusion an analyst should draw?

  1. The project is highly desirable because both calculated IRRs are significantly greater than the cost of capital.
  2. The true rate of return is the average of the two IRRs, which should be compared to the cost of capital.
  3. The project should be automatically rejected because non-conventional cash flows signal unacceptable risk.
  4. The project should be evaluated using MIRR because the existence of multiple IRRs makes the IRR rule unreliable. (correct answer)
Explanation: When you encounter a project with non-conventional cash flows (multiple sign changes), you need to recognize that the standard IRR rule can break down. This project switches from negative to positive to negative cash flows, creating multiple IRRs where the NPV equals zero at both 25% and 400%. The correct approach is answer D. When multiple IRRs exist, the IRR rule becomes unreliable because you can't determine which rate represents the true economic return. The Modified Internal Rate of Return (MIRR) solves this problem by assuming positive cash flows are reinvested at the cost of capital and negative cash flows are financed at the cost of capital, yielding a single, meaningful rate of return. Answer A is wrong because having multiple IRRs above the cost of capital doesn't automatically make a project desirable—you can't reliably interpret what these rates mean. Answer B incorrectly suggests averaging the IRRs, which has no theoretical foundation and provides no meaningful economic insight. Answer C is incorrect because non-conventional cash flows don't automatically signal unacceptable risk—they simply require different evaluation methods. Alternatively, you could evaluate this project using NPV, which remains reliable regardless of cash flow patterns. At 10% cost of capital, calculate whether NPV is positive or negative to make the investment decision. Study tip: Whenever you see cash flows that change signs more than once, immediately think "multiple IRR problem" and remember that MIRR or NPV are your reliable alternatives to the standard IRR rule.

Question 9

A company is evaluating a project where its Internal Rate of Return (IRR) is calculated to be 25%, while its Weighted Average Cost of Capital (WACC) is 10%. An analyst argues for using the Modified IRR (MIRR) instead of IRR. The primary justification for this preference is that the MIRR calculation explicitly assumes that intermediate positive cash flows are reinvested at a rate that is...

  1. equal to the project's calculated IRR of 25%.
  2. a blend of the financing rate and the project's IRR.
  3. more representative of the firm's actual ongoing investment opportunities. (correct answer)
  4. equal to the risk-free rate to provide the most conservative estimate.
Explanation: The core advantage of MIRR over IRR is its more realistic reinvestment rate assumption. IRR implicitly assumes that intermediate cash flows are reinvested at the IRR itself (25% in this case), which is often unrealistically high. MIRR allows for the use of an explicit, more realistic rate, such as the WACC (10%), which reflects the firm's actual opportunities for reinvesting capital.

Question 10

A project requires an initial investment of $100,000. It is expected to generate cash inflows of $40,000 in Year 1 and $80,000 in Year 2, at which point it will terminate. The firm's WACC is 10%, which it uses for both its reinvestment and financing rates. To calculate the project's MIRR, what is the terminal value of the project's positive cash flows at the end of Year 2?

  1. $120,000
  2. $124,000 (correct answer)
  3. $132,000
  4. $145,200
Explanation: The terminal value is the future value of all positive cash inflows at the end of the project's life, compounded at the reinvestment rate. The Year 1 inflow of $40,000 is compounded for one year, while the Year 2 inflow of 80,000isalreadyattheterminaldate.\nTerminalValue=(80,000 is already at the terminal date. \nTerminal Value = (40,000 \times (1.10)^1) + ($80,000 \times (1.10)^0) = $44,000 + $80,000 = $124,000.

Question 11

A project requires an initial investment, followed by several years of positive cash flows. When calculating its MIRR, the firm uses its WACC of 11% as the reinvestment rate and its after-tax cost of debt of 7% as the financing rate. There are no negative cash flows after time zero. How should these rates be applied?

  1. The 7% rate is used to discount the initial investment and the 11% rate is used to discount the inflows.
  2. Both rates are averaged to create a single rate used to compound inflows and discount outflows.
  3. The 7% rate is used to discount all positive cash flows, and the 11% rate is used to compound the initial investment.
  4. The 11% rate is used to compound all positive cash flows to the terminal year, while the 7% rate is not used in the calculation. (correct answer)
Explanation: When you encounter MIRR (Modified Internal Rate of Return) questions, remember that MIRR was designed to address IRR's unrealistic reinvestment assumption by using different rates for different purposes. In this scenario, you have positive cash flows after the initial investment and no subsequent negative flows. This is the simplest MIRR case. The key insight is that MIRR uses the reinvestment rate (WACC of 11%) to compound all positive cash flows forward to the project's terminal year, creating a future value. Then it calculates the discount rate that equates the initial investment to this future value. Since there are no negative cash flows after time zero, the financing rate (7% after-tax cost of debt) becomes irrelevant to the calculation. The financing rate would only be used if you had negative cash flows in later periods that needed to be discounted back to present value. With only positive inflows, you simply compound them all at 11% to the final year. Looking at the wrong answers: Choice A incorrectly suggests discounting both inflows and the initial investment, which isn't how MIRR works. Choice B proposes averaging the rates, which has no basis in MIRR methodology. Choice C backwards the application—it would discount positive flows and compound the investment, which makes no financial sense. Study tip: For MIRR questions, identify the cash flow pattern first. If you see only positive flows after the initial investment, remember that only the reinvestment rate matters—the financing rate sits on the sidelines unused.

Question 12

A company is evaluating two mutually exclusive projects, Project Alpha and Project Beta, which require the same initial investment. Project Alpha has a higher MIRR (18%) than Project Beta (16%). However, Project Beta has a higher Net Present Value (NPV). The firm must choose only one. Which of the following is the most appropriate decision?

  1. Choose Project Alpha because its higher percentage return (MIRR) indicates superior financial efficiency.
  2. Choose Project Beta because NPV is the best measure of the absolute value a project adds to the firm. (correct answer)
  3. Recalculate the MIRR for both projects using the other project's MIRR as the reinvestment rate to break the tie.
  4. Choose neither project until the conflict between MIRR and NPV can be resolved by adjusting the discount rate.
Explanation: In capital budgeting, when conflicts arise between NPV and a rate-of-return measure (like IRR or MIRR) for mutually exclusive projects, the NPV rule should be followed. NPV measures the total dollar value a project is expected to add to shareholder wealth, which is the ultimate goal. MIRR, while a useful relative measure, can be misleading in these cases due to differences in cash flow timing or scale (though scale is equal here).

Question 13

Two mutually exclusive projects, A and B, have the same initial cost and 5-year lifespan. Project A's cash flows are heavily front-loaded (large inflows in years 1-2), while Project B's are back-loaded (large inflows in years 4-5). The firm's reinvestment rate is 10%. Assuming both projects have positive NPVs, which of the following statements is most likely true regarding their MIRRs?

  1. Project A will have a higher MIRR because its early cash flows are compounded for more periods. (correct answer)
  2. Project B will have a higher MIRR because its larger cash flows occur closer to the terminal date.
  3. Both projects will have the same MIRR because their NPVs are positive and initial costs are identical.
  4. The project with the higher IRR will also have the higher MIRR, regardless of cash flow timing.
Explanation: The MIRR calculation involves compounding all positive cash flows to a single terminal value. Cash flows received earlier (front-loaded) will be compounded for more periods at the reinvestment rate. This gives more weight to earlier cash flows, resulting in a higher terminal value and thus a higher MIRR for Project A, all else being equal.

Question 14

A conventional project's IRR is calculated to be 8%, while the firm's WACC is 10%. However, the project's MIRR is calculated to be 11%, using the WACC as the reinvestment rate. Which of the following conditions best explains this apparent contradiction where IRR suggests rejection and MIRR suggests acceptance?

  1. The project must have non-conventional cash flows, causing the IRR to be unreliable.
  2. The project's calculated IRR is an unrealistically high figure, skewing the comparison.
  3. The project's IRR (8%) is lower than the rate at which its cash flows are actually expected to be reinvested (10%). (correct answer)
  4. A calculation error must have occurred, as it is impossible for a project's MIRR to be above the WACC if its IRR is below it.
Explanation: The IRR calculation assumes intermediate cash flows are reinvested at the IRR (8%). The MIRR calculation uses the explicit reinvestment rate (10%). Since the actual reinvestment rate (10%) is higher than the project's own IRR (8%), the MIRR calculation correctly captures the superior returns earned on reinvested cash flows. This boosts the overall project return, 'pulling' the MIRR above the WACC, even though the IRR is below it. This is a key scenario where MIRR provides a more insightful result than IRR.

Question 15

A 2-year project has an initial cost of $5,000. It is expected to return $3,000 in Year 1 and $3,605 in Year 2. The firm's reinvestment rate is 8% and its financing rate is 6%. What is the MIRR of this project?

  1. 16.48%
  2. 17.00% (correct answer)
  3. 20.01%
  4. 32.10%
Explanation: First, find the terminal value (FV) of the inflows at the reinvestment rate (8%). FV = (3,000×1.081)+(3,000 \times 1.08^1) + (3,605 \times 1.08^0) = $3,240 + $3,605 = $6,845. Second, find the present value (PV) of the outflows. Since the only outflow is at t=0, PV = $5,000. Third, find the rate that equates the PV of outflows and the PV of the terminal value: $5,000 = 6,845/(1+MIRR)2.ThissimplifiestoMIRR=(6,845 / (1 + MIRR)^2. This simplifies to MIRR = (6,845 / $5,000)^(1/2) - 1 = (1.369)^(0.5) - 1 = 1.17 - 1 = 17.00%.

Question 16

A company uses its WACC of 12% as both the financing and reinvestment rate. It is analyzing a 3-year project with the following cash flows: Year 0: -1,000;Year1:+1,000; Year 1: +600; Year 2: -200;Year3:+200; Year 3: +800. Which of the following procedures is a correct step in computing this project's MIRR?

  1. Discount the Year 2 outflow of $200 for 2 periods at 12% and add its present value to the initial $1,000 outlay. (correct answer)
  2. Compound the Year 1 inflow of $600 for 3 periods at 12% to find its contribution to the terminal value.
  3. Find the terminal value by summing the future values of the net cash flows for Years 1 through 3, compounded at 12%.
  4. Discount all positive cash flows to year 0 and compound all negative cash flows to year 3, using the 12% rate.
Explanation: The MIRR calculation requires finding the present value (PV) of all cash outflows at the financing rate. The $1,000 at Year 0 is already at its PV. The $200 outflow at Year 2 must be discounted back 2 periods to Year 0. The correct procedure is to calculate PV(outflow at Y2) = $200 / (1.12)^2 and add this result to the initial $1,000.

Question 17

Company XYZ is evaluating a project with the following cash flows: Year 0: -50,000,Year1:−50,000, Year 1: -20,000, Year 2: $80,000, Year 3: $60,000. The cost of capital is 15% and the reinvestment rate is 12%. When calculating MIRR, what is the most appropriate treatment of the Year 1 negative cash flow?

  1. Discount it to present value using the 12% reinvestment rate and add to the initial investment
  2. Discount it to present value using the 15% cost of capital and subtract from the Year 2 positive cash flow
  3. Discount it to present value using the 15% cost of capital and add to the initial investment (correct answer)
  4. Compound it forward to Year 3 using the 12% reinvestment rate and subtract from final cash flows
Explanation: In MIRR calculations, negative cash flows are typically discounted back to present value using the cost of capital (financing rate) and added to the initial investment to create a modified initial outlay. This reflects the cost of financing these negative flows. Choice A is wrong because negative flows use the cost of capital, not the reinvestment rate. Choice B incorrectly subtracts from positive flows rather than adding to initial investment. Choice D incorrectly compounds forward and uses the wrong rate for negative flows.

Question 18

Two projects have identical NPVs of $15,000 when evaluated at a 10% discount rate. Project A has an IRR of 25% and MIRR of 17%, while Project B has an IRR of 20% and MIRR of 16%. The reinvestment rate used for MIRR calculations was 9%. What can be concluded about these projects' cash flow patterns?

  1. Project A has larger early cash flows since its MIRR exceeds Project B's MIRR despite using the same reinvestment assumptions
  2. The projects have identical risk profiles since their NPVs are equal when calculated at the same discount rate
  3. Project A is superior because it has both higher IRR and MIRR, indicating better overall performance characteristics
  4. Project B has a more balanced cash flow distribution since the gap between IRR and MIRR is smaller than for Project A (correct answer)
Explanation: When you encounter questions comparing IRR and MIRR, focus on what the gap between these metrics reveals about cash flow timing. IRR assumes all interim cash flows are reinvested at the IRR itself, while MIRR uses a more realistic reinvestment rate—here, 9%. The key insight is that a larger gap between IRR and MIRR indicates more front-loaded cash flows. Project A shows an 8 percentage point gap (25% - 17%), while Project B has only a 4 percentage point gap (20% - 16%). This tells you Project A generates more of its cash flows early in the project life, making it more sensitive to the reinvestment assumption. Project B's smaller gap suggests its cash flows are more evenly distributed over time, making it less dependent on high reinvestment rates to achieve its returns. Answer A is incorrect because MIRR differences don't directly indicate early cash flow magnitude—they reflect reinvestment sensitivity. Answer B wrongly assumes equal NPVs mean equal risk profiles; risk encompasses factors beyond NPV calculations. Answer C makes the classic mistake of assuming higher IRR and MIRR automatically mean superiority without considering the projects' different cash flow patterns and reinvestment assumptions. The correct answer is D because Project B's smaller IRR-MIRR gap indicates more balanced cash flow distribution over the project's life. Study tip: Remember that large IRR-MIRR gaps signal front-loaded projects that are highly sensitive to reinvestment assumptions, while smaller gaps suggest more balanced cash flow timing.

Question 19

A company's capital budgeting policy requires calculating MIRR for all projects using the firm's WACC as both the discount rate and reinvestment rate. The finance team argues this approach defeats the primary purpose of using MIRR. What is the most valid basis for this argument?

  1. Using WACC for both rates makes MIRR calculations unnecessarily complex compared to simply using IRR or NPV methods
  2. Using identical rates for discounting and compounding will cause MIRR to equal the traditional IRR in all cases
  3. The policy will systematically overstate project returns because WACC is typically higher than market reinvestment rates
  4. WACC represents the cost of capital but may not reflect realistic reinvestment opportunities available to the firm (correct answer)
Explanation: When you encounter MIRR questions, focus on understanding why MIRR was developed as an alternative to IRR. The Modified Internal Rate of Return addresses IRR's unrealistic assumption that cash flows are reinvested at the project's own return rate. The finance team's argument is valid because MIRR's primary purpose is to provide a more realistic measure of project profitability by using achievable reinvestment rates. When you use WACC as both the discount rate and reinvestment rate, you're assuming the firm can reinvest all project cash flows at its cost of capital. However, WACC represents what the firm pays for capital, not necessarily the returns available from reinvestment opportunities. Real reinvestment options might include money market funds, short-term securities, or other projects with different risk profiles and returns. This makes answer D correct. Answer A is wrong because computational complexity isn't the issue—the problem is conceptual validity. Answer B contains a mathematical error; MIRR equals IRR only when the reinvestment rate equals the IRR itself, not when discount and reinvestment rates are equal to each other. Answer C incorrectly assumes WACC is typically higher than market rates, when the relationship varies depending on market conditions and the firm's risk profile. Remember this pattern: MIRR questions often test whether you understand the difference between cost of capital and realistic reinvestment opportunities. The key insight is that these rates serve different economic purposes and shouldn't automatically be assumed equal.

Question 20

A project evaluation shows an IRR of 22%, an MIRR of 16%, and a cost of capital of 12%. The CFO argues that MIRR provides a more conservative and realistic assessment. However, the project manager claims the 22% IRR better represents the project's true profitability. Which statement best addresses this disagreement?

  1. The project manager is correct because IRR measures the actual return generated by the project's cash flows without external assumptions
  2. The CFO is correct because MIRR eliminates the unrealistic assumption that cash flows can be continuously reinvested at 22% (correct answer)
  3. Both measures are equally valid since they both exceed the 12% cost of capital by significant margins
  4. The disagreement is irrelevant because both measures will lead to the same accept/reject decision for this project
Explanation: The CFO is correct. IRR's assumption that all cash flows can be reinvested at 22% is typically unrealistic - most companies cannot continuously find investment opportunities yielding such high returns. MIRR's lower rate reflects more realistic reinvestment opportunities. Choice A is incorrect because IRR does make an implicit reinvestment assumption. Choice C misses the point about which measure is more realistic. Choice D is wrong because while both suggest accepting the project, the magnitude of returns affects resource allocation decisions between projects.