How do you handle multiple IRRs for a project?

2 How to identify multiple IRRs?

One way to identify multiple IRRs is to plot the net present value (NPV) of the project against different discount rates. The NPV is the difference between the present value of the cash inflows and outflows of the project. The IRR is the discount rate that makes the NPV zero. If the NPV curve crosses the horizontal axis more than once, it means that the project has multiple IRRs.

3 How to avoid multiple IRRs?

One way to avoid multiple IRRs is to use a modified internal rate of return (MIRR) instead of IRR. The MIRR assumes that the positive cash flows of the project are reinvested at a specified rate, such as the cost of capital, and that the negative cash flows are financed at the same rate. The MIRR is the discount rate that equates the present value of the negative cash flows and the future value of the positive cash flows. The MIRR eliminates the problem of multiple IRRs by ensuring that the cash flows have only one sign change.

4 How to choose between multiple IRRs?

Another way to handle multiple IRRs is to use a decision rule that helps to select the most appropriate IRR for the project. One such rule is the incremental internal rate of return (IIRR) method. The IIRR method compares the IRRs of different projects or scenarios by calculating the IRR of the incremental cash flows between them. The IIRR method can help to rank the projects or scenarios based on their relative profitability and acceptability.

5 What are the limitations of IRR?

IRR is a widely used measure of project profitability, but it has several limitations that must be taken into account. For instance, it does not account for the size, timing, or risk of the cash flows of the project. Additionally, IRR does not reflect the opportunity cost of capital, which is the return that could be earned by investing in an alternative project or asset. Furthermore, IRR does not provide a unique solution for projects with non-conventional cash flows, as it may have multiple IRRs that are not comparable or meaningful.

6 What are the alternatives to IRR?

Net present value (NPV), profitability index (PI), and modified internal rate of return (MIRR) are alternatives to IRR for evaluating project profitability. NPV accounts for the size, timing, and risk of the cash flows and reflects the opportunity cost of capital. PI measures the value created per unit of investment and can be used to compare projects with different sizes or scales. MIRR assumes a realistic reinvestment rate and eliminates the problem of multiple IRRs. These alternatives provide a more comprehensive measure of project profitability.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?