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A Second Moment Approach to Probabilistic IRR Using Taylor Series

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  • Byung-Cheol Kim
  • Kenneth Reinschmidt

Abstract

This article presents a practical approach for computing the internal rate of return (IRR) of stochastic cash flows. The mean and variance of the distribution of the IRR are derived by a second-moment approach using the means, variances, and correlations of the costs and returns in a cash layout. Programmed as an add-in function, the second-moment algorithm was applied to three examples in the literature and the accuracy of the second-moment method was compared with more sophisticated, computationally intensive methods. The comparison indicates that the second-moment approach can serve as a quick and viable tool for probabilistic IRR analysis.

Suggested Citation

  • Byung-Cheol Kim & Kenneth Reinschmidt, 2012. "A Second Moment Approach to Probabilistic IRR Using Taylor Series," The Engineering Economist, Taylor & Francis Journals, vol. 57(1), pages 1-19.
    • Handle: RePEc:taf:uteexx:v:57:y:2012:i:1:p:1-19
    DOI: 10.1080/0013791X.2011.624677
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