Education Briefing: A review of problematic investment selection issues associated with IRR and NPV benchmarks

James E. Larsen

Journal of Property Investment & Finance, 2024, vol. 42, issue 6, 604-613

Abstract: Purpose - The aim of this Education Briefing is to comment on the problematic issues that sometimes arise when using the internal rate of return (IRR) and/or the net present value (NPV) as a measure of expected investment performance. The briefing looks at the sometimes conflicting signposts that each benchmark presents and highlights ways that decision-makers can overcome or mitigate the effects of those problematic issues. Design/methodology/approach - After a short review of the IRR and NPV techniques, this Education Briefing provides numerous examples of problematic issues that arise with certain cash flow profiles and suggests how to address them. Findings - Both the IRR and NPV provide simple benchmarks that can mislead the decision-maker who is not familiar with the nuances of both techniques. Practical implications - This review should heighten the reader’s ability to spot characteristics of proposed investments that may signal that a quick decision based on performance metrics may lead to disappointing results. These characteristics include: scale effects, unusual cash flow patterns and/or investments with dissimilar expected lives. Mutually exclusive investments merit special attention. Originality/value - This is a review of existing performance measurement models.

Keywords: Crossover rate; EAA; IRR; MIRR; NPV; NPV profile; Reinvestment rate; Replacement chains; Rule of Signs (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jpifpp:jpif-04-2024-0051

DOI: 10.1108/JPIF-04-2024-0051

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