Decision Analysis Working Paper Abstract
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WP030019
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Title: A New Perspective on Multiple Internal Rates of Return
Authors: Gordon
B. Hazen Northwestern University
Date: June2002
Status: Working Paper
The most commonly cited drawback to using the internal rate of return to
evaluate deterministic cash flow streams is the possibility of multiple
conflicting internal rates, or no internal rate at all. We claim, however,
that contrary to current consensus, multiple or nonexistent internal rates
are not contradic tory, meaningless or invalid as rates of return. There
is, moreover, no need to carefully examine a cash flow stream to rule out
the possibility of multiple internal rates, or to throw out or ignore “unreasonable”
rates. What we show is that when there are multiple (or even complex- valued)
internal rates, each has a meaningful interpretation as a rate of return
on its own underlying investment stream. It does not matter which rate
is used to accept or reject the cash flow stream, as long as one identifies
the underlying investment stream as a net investment or net borrowing.
When we say it does not matter which rate is used, we mean that regardless
of which rate is chosen, the cash-flow acceptance or rejection decision
will be the same, and consistent with net present value.
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