Beruflich Dokumente
Kultur Dokumente
Yeomin Yoon
Seton Hall University
Youngna Choi
Montclair State University
Abstract
This work shows the general relationship between the two principal capital budgeting
criteria, and then it attempts to overcome the difficulties caused by cash flows that admit
of multiple values of internal rate of retum (IRR). Modified internal rate of retum
(MIRR) is exposited. and it is thrown into clear relief A rigorous proof that for selecting
among competing (mutually exclusive) projects of equal size, the NPV and the MIRR,
unlike the NPV and the IRR, lead to the same project selection decision is provided.
/. Introduction
//. Definitions
MIRR:
(=0
^ COF, ^ CIF,
IRR: (2)
C.
NPV: NPV = (3)
The temi on tlie left in Equation (I) is simply the present value ofthe
investment outlays when discounted to the cost of capital, and tlie numerator of
the term on the r i ^ t is the sum of the fiiture (terminal) values of the cash flows.
assuming that the cash inflows are reinvested at tlie cost of capital.' Tlie
discount rate that forces the present value of the investment outlays to equal the
present value of the sum of the future (tenninal) values of the cash flows is
deflned as the MTRR.
Cj represents a general cash flow at time t, hence can take either
positive (+) or negative (-) sign. However tlie cash inflow CIF^ and outflow
COFj denote the "amount" of cash flowing in and out, respectively, at a given
time t. hence should always be positive. Sometimes it is convenient and even
necessaiy to assign for each t both C/F, dindCOFj , and it can be done using
C, as follows:
A positive cash flow ( C , > 0) implies a cash inflow, so
2676 The International Journal of Finance
Rearranging the terms in Equation (1) and using Equations (4) and (5),
(6)
c.
fc,{\+ky a
c,
(1 + /M)" (l
-C, C,
t=\ A)' (l + w)"
c. (7)
/M
Net Present Value and Modified Intemal Rate of Return 2377
The term [(l + k)/{l + m)]" in Eqtiation (7) is either larger than I, equal to 1,
or smaller than 1 for ali n
C \ +k
Thus, NPV = is larger than 0 if m > k, equal lo 0
In general, Uie NPV and the MIRR methods provide Uie same capital budgeting
decision for nonnal inveslment projects.
c, y c,{\+ky
2678 The International Journal of Finance
c , y Q (\+ky
c, (9)
vc, >o (1 + * )
As is the case for normal investment projects, the NPV is larger than 0
if m > k, equal to 0 if m = k, and smaller than 0 if m < k Thus, as in the case for
nonnal investment projects, the NPV and MIRR methods provide the same
capital budgeting decision for non-nonnal projects.
End notes
' Throughout the entire project period, the sign for periodic cadi flows changes only
once from plus to negative, or minus to plus.
^ See [3] for a classic example of such a situation that has become known as the "oil-well
pump problem."
^See [ 1 ] for a demonstration that the best reinvestment rate assumption is the cost of
capital for the project Ihat is implicit in the NPV method,
References
3. Theory and Practice, 9"" ed.. Orlando, FL: Dryden Press, 1999, pp.
440-441,
13. D. F. Scott, Jr. and W. J. Petty II, "Capital Budgeting Practices in Large