A Second Moment Approach to Probabilistic IRR Using Taylor Series

Byung-Cheol Kim and Kenneth Reinschmidt

The Engineering Economist, 2012, vol. 57, issue 1, 1-19

Abstract: This article presents a practical approach for computing the internal rate of return (IRR) of stochastic cash flows. The mean and variance of the distribution of the IRR are derived by a second-moment approach using the means, variances, and correlations of the costs and returns in a cash layout. Programmed as an add-in function, the second-moment algorithm was applied to three examples in the literature and the accuracy of the second-moment method was compared with more sophisticated, computationally intensive methods. The comparison indicates that the second-moment approach can serve as a quick and viable tool for probabilistic IRR analysis.

Date: 2012
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DOI: 10.1080/0013791X.2011.624677

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