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Dear Sir,
Please help me in understanding when does a project with multiple IRR have a U shaped graph with negative npv between those 2 percentages and when does it have an inverted U shaped graph with positive Npv between those 2 percentages of IRR. While explaining in kaplan they mentioned it to be an inverted U shaped graph where as in an example they mentioned it to be a U shaped graph which confused me. Please help me understand the difference.
Thank you in advance.
Regards,
Rajvir Singh Oberai.Firstly, there is potentially 1 IRR for every change of sign in the cash flows.
Usually there is an initial outflow followed by a series of inflows. So there is one change of sign, and the curve slopes downwards. There is therefore only 1 IRR.
If there is an outflow followed by inflows and then more outflows, then there are two changes of sign and therefore potentially two IRR’s. There will not always be two IRR’s – it depends on the size of the flows – but there are potentially 2 IRR’s.
If it is an outflow first, then the curve will be u-shaped. If on the other hand it was an inflow first, then it would be an inverted u-shape.If there were outflows followed by inflows followed by more outflows followed by more inflows, then there are three changes of sign and therefore potentially three IRR’s. Again it does not mean there will be three IRR’s – just that potentially there could be.
However all you can be tested on in the exam is that you are aware that there can be more than one IRR. That is all. You cannot be asked to calculate multiple IRR’s and nor can you be asked to draw the graph.
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