Modified Internal Rate of Return: Alternative Measure in the Efficiency of Investments Evaluation

Modified Internal Rate of Return: Alternative Measure in the Efficiency of Investments Evaluation

Mihai Mieila (Valahia University of Targoviste, Targoviste, Romania)
Copyright: © 2017 |Pages: 8
DOI: 10.4018/IJSEM.2017100104
OnDemand PDF Download:
$30.00
List Price: $37.50

Abstract

The evaluation of the efficiency of investments relies on a system of measures based on actuarial techniques that consider the time value of money. One of the common measures used is the Internal Rate of Return (IRR). Commonly, by applying of the efficiency evaluation criteria, result consistent outcomes. In this paper, the author tries to highlight that, based on its theoretical assumptions and practical drawbacks, considering of this measure in evaluation of the investments decisions may lead to erroneous decision. Despite the fact that the Internal Rate of Return (IRR) has never had a favorable academic press, the surveys outline that financial managers seem just to enjoy this measure. The aim of this paper is to summarize the drawbacks of this indicator and to offer a presentation of the Modified Internal Rate of Return (MIRR), as a solution to express a project performance by using of a percentage measure concomitant to discard the unrealistic assumption of reinvestment of cash flow stream just at the value of the IRR, allowing a straightforward calculation.
Article Preview

1. Introduction

The determination of economic performance of investments projects represents a subject of major importance in economics and financial management. The policy of investment must to be based on universally accepted recognized criteria for selection of mutually exclusive projects, as this represents a manifestation of the resources’ limited character. The decisions regarding the opportunity of investing in one particular project or choosing between several options is reliable when it is based on a system of complementary measures, considered as representative.

Usually, the evaluation of the investments’ efficiency relies on a system of measures based on actuarial techniques, commonly used in banking activity. These measures have been adapted to the objectives of the International Bank for Reconstruction and Development, deriving a specific methodology. Then, the same methodology has been adopted in evaluation of the investments financed by other organizations belonging to the system of the United Nations, and also by the European Union.

The criteria used in the activity of investments’ evaluation have to meet some basic requirements: easiness in formulation, synthesizing of the purpose, the possibility to be expressed as much as possible upon a mathematical function and, in order to ensure the measurement of the economic efficiency, to be quantifiable through at least one indicator (Ioniţă, 1994).

The financial and economic data present in the feasibility studies are therefore condensed in a set of measurements in order to reflect the project’s profitability. The most used indicators are the Net Present Value (NPV), as an absolute measure of economic performance, besides a rate of return (most used, the Internal Rate of Return, IRR), as a relative measure of efficiency. Some views expressed in the literature consider that other relative performance measures as Return on Assets (ROA) and Return on Equity (ROE) are financially meaningless and less reliable for economic analysis purposes (Peasnell, 1982; Whittington, 1988; Stark, 2004).

Complete Article List

Search this Journal:
Reset
Open Access Articles: Forthcoming
Volume 6: 4 Issues (2017)
Volume 5: 4 Issues (2016)
Volume 4: 4 Issues (2015)
Volume 3: 4 Issues (2014)
Volume 2: 4 Issues (2013)
Volume 1: 4 Issues (2012)
View Complete Journal Contents Listing