Finance Theory — 18.3: Internal Rate of Return (IRR)

Описание: IRR is one of the most widely taught — and most dangerously misunderstood — metrics in finance. This video defines the internal rate of return, demonstrates the four conditions under which it agrees with NPV, and then systematically breaks it in four distinct failure modes: complex roots, multiple solutions, loan reversal, and scale blindness.

Key concepts covered:
• IRR defined as the discount rate that sets NPV equal to zero
• Bond yield to maturity (YTM) as a real-world application of IRR
• The four conditions for IRR reliability: single outflow at time zero, single project evaluation, constant opportunity cost, and hurdle rate equal to the opportunity cost
• Failure mode 1: alternating cash flow signs producing complex roots (no real IRR exists)
• Failure mode 2: multiple sign changes creating a higher-degree polynomial with multiple real IRR solutions
• Failure mode 3: reversed rankings when evaluating loans instead of investments
• Failure mode 4: scale blindness when comparing mutually exclusive projects of different sizes
• The discriminant of the quadratic formula and why negative values yield complex numbers
• The Fundamental Theorem of Algebra and its implications for polynomial root count
• A decision flowchart for determining when IRR is trustworthy versus when to default to NPV

━━━━━━━━━━━━━━━━━━━━━━━━
SOURCE MATERIALS
The source materials for this video are from    • Ses 18: Capital Budgeting II & Efficient M...