How do you use IRR and sensitivity analysis to support strategic decision making and planning?

IRR in finance is like selecting the most satisfying dish from a menu. It measures an investment's appeal by comparing its initial cost to the returns it generates over time. This 'yum factor' reveals a project's potential profitability, much like how a mouthwatering dish promises satisfaction. Just as chefs balance ingredients for flavor, IRR assesses investments for their financial 'taste.' It aids decision-makers in comparing investment options, much like selecting from diverse dishes. This allows for choosing the most appealing investment—the one with the highest IRR. It respects diverse risk preferences, aligning investments with individual goals.

The IRR is a fundamental financial tool for evaluating investment profitability. In strategic decision-making, the IRR serves as a crucial prioritization criterion, assisting leaders in efficiently allocating resources among different projects. However, the utility of the Internal Rate of Return (IRR) goes beyond simple project selection. In long-term financial planning, it allows for estimating expected returns and determining if they align with financial and strategic objectives. This alignment ensures that investments support sustainable growth and minimize financial risk. The IRR should not be considered in isolation but integrated with other indicators, facilitating more informed and robust decision-making processes.

I use IRR (Internal Rate of Return) to assess the potential profitability of projects and compare them to decide which ones align best with strategic goals. It helps in understanding the expected returns and in choosing projects that maximize value. Sensitivity analysis complements this by testing how changes in key assumptions, like costs or revenues, impact the IRR. This combination allows for better risk assessment and prepares for different scenarios. By using both IRR and sensitivity analysis together, I can support strategic planning with data-driven insights, balancing potential returns against possible risks.

In my experience IRR and MIRR especially will make projects look way more favourable than they are. Often they don't properly capture the length of a project (under-estimated). In most cases cost takeouts are only ever partially realized, also leading to over estimation.

While useful tools, IRR, NPV, and sensitivity analysis will almost always skew favourably. The human bias in the presentation often influences the outcome. In addition these tools should be considered holistically. Strong managerial caution should be used to question underlying assumptions and also value the opportunity cost of funding the project. A given project is never worth the stated business case. At best it is the stated business case minus the simple interest earned on the same dollars.

I agree with utilizing NPV and IRR. However, when evaluating a project, decision-makers should consider other similar projects before committing to an investment. The NPV and IRR of a project may be acceptable, but how does it compare to that of a similar product or project? Another factor to consider is the duration of the project. Comparable projects with a shorter duration typically have a greater chance of success.