Comment: The Unique, Real Internal Rate of Return

Abstract

beware of a unique, real internal rate of return (IRR) because such a return is incorrect measure of the return on for a mixed project. While it is true, as discussed by Teichroew, Robichek and Montalbano (TRM) [4], and now by Herbst, that a mixed project may have a unique IRR, several additional observations developed by TRM should be added to Herbst's discussion. These comments will clarify the implications of Herbst's paper for a decision maker who has a mixed project with a unique real IRR. In particular for a mixed project with a unique IRR, it is immediately evident from TRM's discussion that under conditions of no capital rationing both the IRR and net present value (NPV) decision models lead to a correct accept/reject investment decision [4, pp. 168-171]. However, the unique real IRR of a mixed project ignores the sourceof-funds phase of the project. In this sense the buyer should beware. One should also beware of Herbst's examples. Cases 3 and 4, which form the core of Herbst's discussion of the implications of mixed projects with unique, positive IRRs, are ill-conceived. In case 3, it is easily shown that the IRR is minus 36 percent, not plus 36 percent as claimed by Herbst. Case 4 has a repeated root at an IRR of 100 percent and thus leads to a number of special considerations which should be clarified. In order to remove any residual doubt in the reader's mind as to what these IRRs really are, a plot of each NPV function is shown in Figure 1. A third example of a mixed 2