Double vision: Insights about the origin and interpretation of multiple IRRs

Morris G. Danielson

The Engineering Economist, 2018, vol. 63, issue 3, 217-235

Abstract: The ability of a project's internal rate of return (IRR) to quantify its economic return has been questioned by many scholars over the past 60 years, most recently by Magni (2010, 2013). Although IRR is a plausible—albeit imperfect—measure of a project's economic return when the cash flow stream is conventional, IRR can be an untenable measure of an unconventional project's economic return. The goal of this article is to identify a simple, intuitive explanation of IRR, one that can be applied to any cash flow pattern. To do this, the article shows how a project's IRR systematically changes when it first crosses from the conventional into the unconventional realm (i.e., a small cash outflow is appended to a conventional cash flow stream) and then as it becomes progressively more unconventional. This process reveals that the most robust economic interpretation of IRR—for both conventional and unconventional projects—is that a project's IRRs are external benchmarks that divide the set of all plausible discount rates into positive and negative net present value (NPV) ranges, rather than internally generated returns. Because it can be difficult to estimate a project's cost of capital with precision, this information can help guide the sensitivity analysis of a project.

Date: 2018
References: Add references at CitEc
Citations:

Downloads: (external link)
http://hdl.handle.net/10.1080/0013791X.2017.1391361 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:uteexx:v:63:y:2018:i:3:p:217-235

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/UTEE20

DOI: 10.1080/0013791X.2017.1391361

Access Statistics for this article

The Engineering Economist is currently edited by Sarah Ryan

More articles in The Engineering Economist from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().