Modified Profitability Index and Internal Rate of Return

Abstract

Modified Profitability Index and Internal Rate of Return Armênio de Souza Range, José Carlos de Souza Santos, José Roberto F. Savoia Abstract Both the internal rate of return (IRR) and the net present value(NPV) methods present well-known limitations. The drawbacks of the IRR include multiple rates, the assumption that cash flows are reinvested at the IRR, and the scale effect, whereas in the case of NPV the limitations relate to the choice of the measurement units as well as to the project’s scale. In many cases, applying these two methods produces conflicting rankings for alternative investment projects. Two alternative models were developed to overcome these pitfalls: the modified internal rate of return method (MIRR), which overcomes the IRR’s limitations, and the profitability index (PI), which resolves the limitations of NPV. The purpose of this paper is to show that there are no inconsistencies between the PI and MIRR, and that it is preferable to use a modified rate, the MPI, which is obtained by subtracting the cost of capital from the standard PI. Full Text: PDF DOI: 10.15640/jibe.v4n2a2