A Second Moment Approach to Probabilistic IRR Using Taylor Series

摘要

This article presents a practical approach for computing the internal rate of return (IRR) of stochastic cashflows. 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.