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2012•Journal of Finance IssuesOpen access

Why Do Managers Use IRR in Investment Analysis?

Nalinaksha Bhattacharyya

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Abstract

Finance textbooks recommend the use of Net Present Value (NPV) as the evaluation tool for Capital Budgeting. Yet surveys of managers have consistently shown that managers prefer Internal rate of Return (IRR) to NPV. This article rigorously establishes the interpretation of IRR as the return earned on funds that remains internally invested in the project. Using this interpretation IRR can be viewed as a tool to evaluate the riskiness of the capital budgeting proposal.

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Finance textbooks recommend the use of Net Present Value (NPV) as the evaluation tool for Capital Budgeting. Yet surveys of managers have consistently shown that managers prefer Internal rate of Return (IRR) to NPV. This article rigorously establishes the interpretation of IRR as the return earned on funds that remains internally invested in the project. Using this interpretation IRR can be viewed as a tool to evaluate the riskiness of the capital budgeting proposal.

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Available abstract

Finance textbooks recommend the use of Net Present Value (NPV) as the evaluation tool for Capital Budgeting. Yet surveys of managers have consistently shown that managers prefer Internal rate of Return (IRR) to NPV. This article rigorously establishes the interpretation of IRR as the return earned on funds that remains internally invested in the project. Using this interpretation IRR can be viewed as a tool to evaluate the riskiness of the capital budgeting proposal.

Key concepts: Internal rate of return, Capital budgeting, Modified internal rate of return, Net present value, Rate of return, Interpretation (philosophy), Value (mathematics), Return on investment

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