Handling Multiple IRRs in Money-Weighted Investment Returns

Summary

Money-weighted return is an internal rate of return computed from an investment’s dated cash flows. When those flows change sign multiple times, the return equation can have more than one solution, so the reported rate may not uniquely describe performance. The document asks how to interpret this problem when the metric is used to evaluate an investment rather than a project.

The response offers two approaches: select the IRR that is most plausible for the case, or evaluate net present value using a discount rate chosen from investments with comparable risk. It stresses that NPV does not remove the need for judgment: multiple IRRs mean multiple rates make NPV zero, so the discount rate must be appropriate. The answer is brief and supplies no general procedure for choosing among plausible rates, nor examples beyond an illustrative contrast. These methods therefore provide decision guidance, not a universal resolution for ambiguous cash-flow patterns.

Key ideas

• Cash flows with multiple sign changes can produce more than one internal rate of return.
• Multiple IRRs make a single money-weighted return difficult to interpret.
• One option is to choose the IRR that best fits the investment context.
• An alternative is to use NPV with a discount rate grounded in comparable-risk investments.
• NPV remains dependent on selecting a defensible discount rate.

Tags

# How to calculate Money-weighted Rate of Return when there are multiple negative cash flows during investment period?


# How to calculate Money-weighted Rate of Return when there are multiple negative cash flows during investment period?












I know that when there are multiple changes of sign in the sequence of cash flows of a project, the project may have multiple IRR, which render this criterion impractical. Therefore, in such situations, avoiding IRR and using other criteria, particularly NPV, is often advocated. Now, my question is that if this problem occurs in the context of calculation of Money-weighted Rate of Return of an investment, what should be done? (Regarding that Money-weighted Rate of Return is just IRR and criteria such as NPV cannot be utilized in this situation)

## Answer by D Stanley (score 1)

https://quant.stackexchange.com/a/50783

> Therefore, in such situations, avoiding IRR and using other criteria, particularly NPV, is often advocated.

This is true if you have an appropriate discount factor to use. Note that, by definition, if a cash flow stream has multiple IRRs, that means that there are multiple discount rates for which the NPV is zero, so choosing an appropriate discount rate is critical for a meaningful NPV.

So you can either 1) choose the IRR that is more reasonable in your case (e.g. if you get IRRs of 5% and 200%, then the 5% is probably more reasonable), or 2) choose an appropriate discount factor based on projects of similar risk and use the NPV rule.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.