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On the long-standing issue of the internal rate of return: a complete resolution

Author

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  • Carlo Alberto Magni
Abstract
The IRR problem. As widely known, the IRR has serious flaws: (i)multiple real-valued IRRs may arise, (ii) the meaning of each IRR may be ambiguous (rate of return or rate of cost?), (iii)complex-valued IRRs may arise, (iv) the IRR is, in general, incompatible with the net present value (NPV) in accept/reject decisions and the IRR ranking is, in general, different from the NPV ranking, (v)the IRR decision criterion is not applicable with variable costs of capital. Since the origins of the notions (Boulding 1935, 1936; Keynes 1936), the IRR drawbacks have stimulated an immense bulk of contributions over the decades investigating this issue and searching for some solution (see references in Gronchi 1987 and in Magni 2010a). We here present two autonomous solutions which solve the IRR problems completely by dismissing the traditional the IRR equation and considering a simple mean of period rates. As a pleasant byproduct, we find that accounting rates of return are meaningful economic rates of return, whereas the IRR is just a particular case of the mean of period rates.

Suggested Citation

  • Carlo Alberto Magni, 2010. "On the long-standing issue of the internal rate of return: a complete resolution," Proyecciones Financieras y Valoración 7126, Master Consultores.
    • Handle: RePEc:col:000463:007126
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    More about this item

    Keywords

    internal rate of return; capital; net present value; accounting rate of return;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • N01 - Economic History - - General - - - Development of the Discipline: Historiographical; Sources and Methods

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