Multiple IRR

Multiple IRR

In real life, you would find many projects that have more cash outflows in addition to initial cash outflow. In such cases there may be more than one discount rate that can result in Zero NPV of those projects and there may also be a case where there is no discount rate that will result in zero NPV. So, you can expect strange results when you deal with nonconventional cash flows. But NPV does not have this problem and gives theoretically correct decisions for projects with non conventional cash flows. So you should not get upset if you come across projects with non conventional cash flows because NPV rule still apply and you can always go with that.

IRR Problems:

It is difficult to find return on projects with non conventional cash flows because in such projects we face Multiple Rate of Return problem and IRR can be misleading when

  • We compare two or more projects to see which one is viable.

  • There is a possibility that more than one rate of return result in zero NPV when we discount cash flows.

The question is: Is there any way that can help us in determining that whether or not we have found all possible IRR of a project with nonconventional cash flows?

The answer is YES.

Descartes’ s Rule of signs states that maximum number of IRR is equal to number of times sign of cash flows change from positive to negative or vice versa.

Can different financial softwares help in finding all possible IRRs of such projects?

No, as most of such programs are unable to identify this problem and just show the first IRR they found. Many programs just report smallest positive IRR.

Multiple IRRAdminCapital Budgeting TechniquesIRRIRRMultiple IRR In real life, you would find many projects that have more cash outflows in addition to initial cash outflow. In such cases there may be more than one discount rate that can result in Zero NPV of those projects and there may also be a case where there is no discount rate...Investment analysis basics