The practical problem of false high internal rate of return

Internal rate of return (IRR) is an important index in investment project evaluation.StarlightprincessIt embodiesStarlightprincessThe profitability of investment. However, in practical application, IRR sometimes appears the phenomenon of false height, which misleads investors' decision-making. This paper will discuss the causes and practical problems of false height of IRR.

First of all, we need to understand the calculation principle of IRR. IRR is the discount rate that makes the net present value (NPV) of an investment project equal to zero. Net present value is the sum of future cash inflows minus cash outflows, and the discount rate refers to the current value of future cash flows. Therefore, the calculation of IRR involves the prediction of future cash flow and the choice of discount rate.

oneStarlightprincess. Inaccurate cash flow forecast

One of the important reasons for the false high of IRR is the inaccurate forecast of future cash flow. When evaluating projects, enterprises often need to predict the benefits and costs in the next few years. However, many factors such as market environment, policies and regulations and industry competition will affect the future cash flow of enterprises. Too optimistic or too pessimistic forecasts will lead to false high IRR.

twoStarlightprincess. The choice of discount rate

The choice of discount rate is also an important factor affecting IRR. When calculating IRR, enterprises usually use weighted average cost of capital (WACC) as the discount rate. However, the WACC of different enterprises may be different, and even the WACC of the same enterprise may change in different periods. In addition, too high discount rate may lead to false high IRR.

3. Time distribution of cash flow

The time distribution of cash flow will also affect the calculation results of IRR. In investment projects, the distribution of cash flow is often non-linear. When there is less cash flow in the early stage of the project and more cash flow in the later stage, it may lead to false high IRR. This is because the time value of cash flow is ignored, which leads to the excessive weight of cash flow in the later stage.

4. Project scale

The impact of project size on IRR can not be ignored. Large-scale projects usually have high investment threshold and risk, which may lead to false high IRR. In addition, large-scale projects often involve multiple sub-projects, and the complexity of cash flow forecast and discount rate selection will also increase the possibility of false high IRR.

In order to solve the problem of false high IRR, investors and enterprises can take the following measures:

1. Enhance the accuracy of cash flow forecast

Enterprises should combine the market environment, policies and regulations and industry competition and other factors to make a more reasonable forecast of future cash flow. In addition, enterprises can use a variety of forecasting methods, such as sensitivity analysis, scenario analysis, etc., to improve the accuracy of prediction.

two。 Reasonable selection of discount rate

Enterprises should choose a more appropriate discount rate according to the actual situation. In addition to WACC, enterprises can also consider using the industry average discount rate, historical discount rate and so on as a reference. At the same time, enterprises should pay attention to the change of discount rate and adjust IRR calculation in time.

3. Consider the influence of time distribution of cash flow

When evaluating a project, enterprises should pay attention to the time distribution of cash flow. For the cash flow with nonlinear characteristics, we can consider using the modified IRR calculation method, such as modified internal rate of return (MIRR), to eliminate the influence of the time value of cash flow.

4. Comprehensive assessment of project risk

When evaluating the project, investors and enterprises should not rely too much on IRR indicators, but should comprehensively evaluate the risk of the project from multiple angles. In addition to cash flow forecasting and discount rate selection, attention should also be paid to market competition, technological innovation, policies and regulations of the project, so as to make more reasonable investment decisions.

In a word, the false high internal rate of return is a practical problem worthy of attention. Investors and enterprises should improve the accuracy of IRR calculation in many ways to avoid misleading investment decisions. Only by comprehensively evaluating the risk of the project and making a more wise investment choice can we maximize the return on investment.