Hi WSO,
I'm computing the IRR on a project that is projected to have negative cash flows for about 3 years, and then cash flows are projected to be positive after that. If you run an IRR calculation in excel on those calculations, what exactly does that mean?
It's easy for me to internalize the meaning in say a simple LBO context, with an outflow of 100 at the outset, and a 300 inflow at the end of year five. I can compute the 300 by growing the 100 investment at the IRR compounded over the five years. I can't do that in the first fact scenario, so its harder for me to explain the IRR output as the "effective compounded annual growth rate" over the projection period. Could you provide some additional color to help me have a better intuition? How would you explain this to a top executive who pushed you on it a bit?
Thank you!
Is the IRR you are getting in the first fact scenario negative or below your hurdle? I would consider explaining it as the minimum required rate of return on the cash flows for you guys to accept the project. Any more detail you can share? Am I off base?
Agreed. If you're not comfortable with the idea of IRR being an effective CAGR, it also makes sense to think of it as the discount rate that tells you what the received cash flows are worth.
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