CFA CFA Level 1 how do you figure out the IRR of 260%?

# how do you figure out the IRR of 260%?

• Author
Posts
• pcunniff
Participant
• CFA Level 1
11

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

A)

It has two IRRs of approximately 38% and 260%.

B)

It has a single IRR of approximately 38%.

C)

No IRRs can be calculated.

Explanation

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%.

10,000 Ã· 1.38 – 10,000 Ã· 1.382 = 1995.38

And:

10,000 Ã· 3.6 – 10,000 Ã· 3.62 = 2006.17

Both discount rates give NPVs of approximately zero and thus, are IRRs.

• rahul12
Participant
• CFA Level 3
2

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 IRRâ€™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 IRRâ€™s, so that eliminates answer B, therefore the answer is A.

• pcunniff
Participant
• CFA Level 1
2

I got the concept on multiple IRRs. Thanks again bud!