Weaknesses of IRR Method
Alpin McGregor, freeelance, United Kingdom, Member
The easiest way of looking at weakness of IRR model is by comparing 2 situations:
1. You have $1 and earn 100% rate of return in one year. You will have $2 at the end of the year.
2. You have $100 and earn 10% rate of return in one year. You will have $110 at the end of the year.
If you base your decision on Internal Rate of Return you will always prefer situation 1.
If you base your decision on NPV you will always prefer situation 2.
The problem in real life situations is that if you could find 100 projects of $1 that will give you 100% return then clearly that is better than one project of £100 at 10% rate of return.