Which factor must be adjusted when calculating MIRR to reflect realistic investment conditions?

In calculating the Modified Internal Rate of Return (MIRR), the reinvestment rate of cash inflows is a critical factor that must be adjusted to reflect realistic investment conditions. The MIRR provides a more accurate reflection of the profitability of an investment by considering not only the financing costs but also the reinvestment rate of the cash flows received from the investment.

Traditional Internal Rate of Return (IRR) assumes that cash inflows are reinvested at the same rate as the IRR itself, which may not be realistic. MIRR addresses this limitation by allowing the analyst to specify a more reasonable rate for reinvesting those cash flows, which could be based on the company’s cost of capital or a market rate. By incorporating this more plausible reinvestment rate into the MIRR calculation, it ensures that the result is more reflective of the actual returns an investor can expect, thus providing a clearer picture of the investment’s viability.

In contrast, while factors like inflation, the initial investment cost, and duration of cash flows are important considerations in the broader context of investment analysis, they do not directly influence the MIRR calculation in the same way the reinvestment rate of cash inflows does. Adjusting for the reinvestment rate