Internal rate of return - part 2

In this lesson

1. 0:00 Introduction to IRR calculation
2. 1:31 IRR formula and calculation method
3. 2:59 Interpreting results with sense checks
4. 3:23 IRR merits and advantages
5. 5:01 Mutually exclusive projects problem
6. 5:53 Reinvestment rate assumption flaw
7. 7:01 Abnormal projects and multiple IRRs
8. 8:13 IRR versus NPV conflict resolution

About this lesson

This video walks you through a worked example, shows you the step-by-step calculation, and then explores both the strengths and limitations of IRR as an investment appraisal technique—including why it can sometimes conflict with NPV when choosing between projects. The core technique uses linear interpolation: you take your positive NPV discount rate, add the ratio of the positive NPV to the difference between both NPVs, then multiply by the difference between your two discount rates. The worked example demonstrates how to handle negative figures in the calculation and why it's useful to estimate your answer beforehand as a sense check. You'll also learn how to round your result to the nearest percentage for exam purposes. Beyond the calculation, this lesson covers the practical merits and drawbacks of IRR. It's easily understood across a business because percentage returns are intuitive to communicate, and it properly accounts for the time value of money. However, IRR has real limitations: it struggles with mutually exclusive projects where a higher percentage return might represent a smaller absolute investment, it assumes unrealistic reinvestment rates, and abnormal cash flow patterns can produce multiple or zero internal rates of return. Critically, IRR can sometimes recommend a different project than NPV would—and since NPV is the superior method for maximising shareholder wealth, understanding when and why these conflicts arise is essential for making sound investment decisions.

Duration: 10m