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What is an Investment Project's Implied Rate of Return?

Graham N. Bornholt

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Abstract

How to measure a project's implied rate of return has long been an unresolved problem, except for some special cases. This paper derives return on present cost (ROPC) as the correct measure of an investment project's implied rate of return. The IRR is a biased measure except for projects classified as simple projects, and this bias is likely to be substantial in many real‐world applications. Thus while net present values should be used to determine whether to accept/reject projects, I recommend that analysts use ROPC in place of the IRR as a measure of a project's true rate of return.

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What this paper is about

How to measure a project's implied rate of return has long been an unresolved problem, except for some special cases. This paper derives return on present cost (ROPC) as the correct measure of an investment project's implied rate of return. The IRR is a biased measure except for projects classified as simple projects, and this bias is likely to be substantial in many real‐world applications. Thus while net present values should be used to determine whether to accept/reject projects, I recommend that analysts use ROPC in place of the IRR as a measure of a project's true rate of return.

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Available abstract

How to measure a project's implied rate of return has long been an unresolved problem, except for some special cases. This paper derives return on present cost (ROPC) as the correct measure of an investment project's implied rate of return. The IRR is a biased measure except for projects classified as simple projects, and this bias is likely to be substantial in many real‐world applications. Thus while net present values should be used to determine whether to accept/reject projects, I recommend that analysts use ROPC in place of the IRR as a measure of a project's true rate of return.

Key concepts: Internal rate of return, Rate of return, Measure (data warehouse), Modified internal rate of return, Return on investment, Economics, Investment (military), Time-weighted return

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