IRR Rules And Caveats

Internal Rate of Return Rules and Caveats

Fundamental Rules

  1. For go/no-go decisions on a single project without constraints: go if internal rate of return is greater than appropriate discount rate.
  2. For choosing among alternatives, USUALLY you can choose the project with the highest IRR, BUT
    • can depend on discount rate — different project may be preferred at one discount rate than another and IRR can obscure this
    • may mask the fact that doing nothing may be better option
  3. Variation, "undertake project if IRR > X" can lead to indeterminate results under some conditions


IRR approach only works if

  1. no budget constraints
  2. projects do not preclude one another
  3. net returns start negative and then get positive (more costs up front)

And so, the BOTTOM LINE: choose mix of projects yielding highest present value.