explanation is vague – please help! How do you figure out the IRR of 260?
Which of the following statements about the internal rate of return (IRR) for a project with the following cash flow pattern is CORRECT?
Year 0: -$ 2,000Year 1: $10,000Year 2: -$ 10,000
It has two IRRs of approximately 38% and 260%.
It has a single IRR of approximately 38%.
No IRRs can be calculated.
The number of IRRs equals the number of changes in the sign of the cash flow. In this case, from negative to positive and then back to negative. Although 38% seems appropriate, one should not automatically discount the value of 260%.
Check answers by calculation:
10,000 ÷ 1.38 – 10,000 ÷ 1.382 = 1995.38
10,000 ÷ 3.6 – 10,000 ÷ 3.62 = 2006.17
Both discount rates give NPVs of approximately zero and thus, are IRRs.
actually there’s no need to use a calculator once you’ve grasped the concept.
when you see the cashflow profile, it’s an ‘unconventional’ one with sign changes throughout:
In a ‘normal’ project, you would expect a cash outflow upfront (or in the earlier years), before it pays back with positive cashflows in future years, i.e. there is only 1 sign change, meaning 1 IRR value exist.if you have unconventional cash flows (ie. there are more than 1 sign changes as per example above), you will have multiple IRR’s. Once you understand this, you can automatically discount answers B & C. The only way you could ever have no IRR would be if all the project cashflows has 1 sign only (e.g all outflows), so that eliminates answer C. Unconventional cash flows have multiple IRR’s, so that eliminates answer B, therefore the answer is A.
- You must be logged in to reply to this topic.