The McKinsey Quarterly: Internal rate of return: A cautionary tale
I was just preparing for class and came upon a great article from McKinsey Quarterly (published by Wharton) that gives some reasons why the Internal Rate of Return may not be all that it is cracked up to be.
IRR may lead to the wrong investment decision more often than we thought! And to make matters worse, many who are using IRR, are not even aware of the flaws (and in particular the problems with the reinvestment rate assumptions!)
As the authors John C. Kelleher and Justin J. MacCormack state: "Our next surprise came when we reanalyzed some two dozen actual investments that one company made on the basis of attractive internal rates of return. If the IRR calculated to justify these investment decisions had been corrected for the measure's natural flaws, management's prioritization of its projects, as well as its view of their overall attractiveness, would have changed considerably."
BTW this is why I love the blog idea so much. Why share the information only with those in class, why not all past students, fellow professors, and just anyone who is interested in finance! And it si so easy. Technology creates such leverage!