Weird IRR pattern
Hi everybody. I work at a private equity firm and recently stumbled upon a weird IRR pattern.
A simplified example looks the following way. Say, there are two sets of cash flows:
(1) = -4 ; 2 ; 4 ; -3 ; -1; 6 ; -3 ; 8 (2) = -4 ; 2 ; 4 ; -4 ; -1; 6 ; 0 ; 8
The IRR of the first row is 34.7% vs 35.7% for the second row. As it can be seen, the first three cashflows are the same in both cases (-4 ; 2; 4).
The IRR of CFs in the first row excluding the aforementioned first 3 figures is 44.8% as opposed to 44.7% in the second row. Here is what I have a hard time explaining - why is the IRR of the whole first row is lower than of the second row, whereas when we exclude first 3 CFs (which are are identical) it suddenly becomes higher compared to the second row?
Many thanks for your answers in advance!
I'm getting the 44.7% when you exclude (2,4,-4) from the 2nd set, but getting 32.3% from the 1st set when you exclude the same first three numbers. I'm running dates from 12/31/2016 to 12/31/2023.
Anyway, this isn't exactly the most mathematical response, but as for why 2nd set (with all #'s) is higher than 1st set - 2nd set delta in 12/31/19 (-3 vs -4) is only 1 whereas delta in 2022 (-3 vs 0) is 3 which impacts return profile positively for 2nd set given higher dollar return.
2nd set having IRR of 44.7% through 12/31/2020 (lopping off first 3 #'s you stated) is really just a function of return vs. time. You're recouping $13 after putting in $4 over 4 years, which generates a higher IRR than generating $15 over 7 years.
Thanks for your reply. You got 32.3% IRR in the 1st case because you had CF #4 as -4 instead of -3. What I'm trying to understand is how can the IRR of the first row be higher, but when you exclude first 3 identical CFs (in both rows) it becomes lower than in the second case.
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