Question

List and explain (in one to two sentences each) three problems with IRR, and whether or not MIRR solves each problem (you can note this for each problem after you explain the problem). Your explanation should include why these are problems (why we can't just ignore these issues).

Answer 1

The problems with IRR

1) The IRR incorporates an assumption that cash inflows from the project will be reinvested at the internal rate of return.

MIRR  improves on IRR by assuming that positive cash flows are reinvested at the firm's cost of capital.

2) If a project is unconventional (has negative cash flow or flows after year 0), it will have more than one IRR or the IRR may not able to calculate. The IRR produces more than one number, causing uncertainty and confusion.

MIRR solves this issue as well.

3) when the investments are mutually exclusive and are of different sizes or have different cash flow patterns, the information provided by the IRR may not be useful for decision making.

When the investments are mutually exclusive the project with the highest MIRR is the most attractive.