>>Is there a trick when calculating the IRR when all the periods are negative.
No. If all of the cash flows are negative, then there is no solution.
Remember what IRR is: the discount rate such that, when it is applied to all of the cash flows, produces an
NPV of zero. If all of the flows are negative, then there is no such discount rate.
>>I understand that there must be both positive and negative numbers in the periods in order for it to work,
>>but then how does one decide between two "bad" projects? - Using the IRR function of course
The right answer is, no matter what sign any of the cash flows has, to use NPV instead of IRR. I will repeat
here my standard screed against IRR:
I urge you to be very careful in using internal rates of return. IRR--the finance construct itself, and not just the
Excel functions IRR(), XIRR(), and MIRR()--is, simply put, not reliable, and prioritizing investment decisions
on an IRR basis can lead to bad decision-making. You should use net present value (NPV) instead.
1) Depending on the nature of the cash flows, there can actually be more than one IRR. (The number of IRR
results will match the number of times the stream of cash flows changes signs.)
2) Some scenarios can have very high IRR but actually have negative NPV using any rational discount rate.
Illustrating both... Consider the following cash flows:
Today, -1,600
1 year from now, 10,000
2 yrs from now, -10,000
This stream actually has two IRRs: 25%, and 400%, both of which sure look attractive. Yet, any reasonable
discount yields a negative NPV.
Bottom line: trust NPV, and eschew IRR.
Regards,
Patrick
