Internal Rate of Return

As we noted in chapter 5, one reason many firms continue to use internal rate of return rather than net present value in their investment decisions is because they perceive themselves to be subject to capital rationing. Since the internal rate of return is a percentage measure of return, it measures the return to a dollar of invested capital and provides a way of directing capital to those investments where this return is highest. The limitations of the IRR approach were also examined in chapter 5, especially with its reinvestment rate assumptions and the potential for multiple and misleading internal rates of return.

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