Business 650 Managerial Finance
Professor Rick Kwan
September 17, 2012
The Modified Internal Rate of Return is an underused measure for selection of projects that a company can choose because it is more effective at dealing effectively with periodic free cash flows that develop from the time that an asset is purchased through its life to the point where it is sold, ranking projects and variable rates of return through the project life. The Internal Rate of Return is an inefficient model to make decisions with because it lack the ability to account for the periodic free cash flows, proper ranking and variable returns from certain projects. The use of Internal Rate of Return in business as a method to evaluate how attractive an investment is for a corporation has been one of the most popular for the Fortune 1000 companies. Of the Fortune 1000 companies that responded to a survey on what they use evaluate investment options seventy six percent indicated that they use the Internal Rate of Return. Their preference is due to the fact that the Internal Rate of Return appeals to the intuition of top executives and because it deals mainly with percentages (Ryan and Ryan, 2002). There are attractive features to the Internal Rate of Return in that it uses cash flows as opposed to accounting income, time value of money is accounted for, cash flows from the relevant period of time for the project, compares projects, comparison with a hurdle rate and relates to the corporations goals. In this same survey three percent of the firms use the Modified Internal Rate of Return. The three percent that use the Modified Internal Rate of Return indicate that they use it because incorporates a more realistic investment rate, also uses cash flows instead of accounting income, it is easy to understand and is easy to compute. (Burns and Walker, 1997). Although the Internal Rate of Return is used more frequently at seventy six percent than the Modified Internal Rate of Return at three percent, the Internal Rate of Return may not be the best tool to evaluate the project or projects that a corporation is considering (Keef and Olowo-Okere, 1998). The Internal Rate of Return is one of the closest methods that will mimic the Net Present Value, one of the better standards in project evaluation. The way that the Internal Rate of Return indicates that a project should be taken on is with a single number. This number is a summary of the benefits of the project in question and is based on the company’s internal rate of return on the project and is dependent on the cash flows of the project. For the Internal Rate of Return projects are accepted where the internal rate of return is greater than the discount rate and rejected where the Internal Rate of Return is less than the discount rate. In Internal Rate of Return the discount rate is where the net Present Value is zero (Ross, Westerfield, Jaffe and Jordan 2011). There are several problems with the Internal Rate of Return and they are the reinvestment assumption, ranking of mutually exclusive projects when a company needs to decide on one to pursue, timing, and multiple changes in the sign of a project and projects that have multiple Internal Rates of Returns. A fundamental problem with the Internal Rate of Return is that it doesn’t take into account cash flows that can be realized from investments that can be used to reinvest in other endeavors that can produce more positive cash flows (Kierulff, 2008). On a regular basis my company and I work with hospital systems providing them with purpose built hardware and software to improve the work flows for patient access to care. Utilizing these technologies to improve access in an automated way reducing costs in full time equivalent time, supplies costs, improving the efficiency of the clinic or hospital, allowing front desk employees to be trained in revenue generating skills,...