What does the modified internal rate of return (MIRR) address that traditional IRR does not?

The modified internal rate of return (MIRR) improves upon the traditional internal rate of return (IRR) by addressing one of its primary limitations: the reinvestment rate assumption. Traditional IRR assumes that interim cash inflows are reinvested at the same rate as the IRR itself, which can often be unrealistic and overly optimistic. In contrast, MIRR assumes that these cash inflows are reinvested at a more conservative financing rate—typically the firm’s cost of capital or the market rate—rather than the calculated IRR. This adjustment generally provides a more accurate reflection of a project’s profitability by using a realistic rate for reinvestment, thus leading to more informed investment decisions. This fundamental difference is why option B is the correct answer when discussing the distinction between MIRR and traditional IRR.