## Investigating possible bias issues arising from improper use of the internal rate of return when used for decision-making on renewable energy technology investments

Ms Tanja Groth, Aarhus University/Stirling.DK ApS The internal rate of return (IRR) is, together with net present value (NPV), the most commonly used investment decision tool for management (Ryan and Ryan, 2002). Presented as a simple percentage, it is an easily grasped concept which readily lends itself to instant investment comparisons. The IRR is often used in conjunction with net present value (NPV) calculations to estimate the benefit of a given investment decision. Simply put, the IRR is the rate at which the benefits from an investment are equal to the investment itself. However, using the IRR calculation indiscriminately can result in errors, particularly when disregarding the implicit reinvestment assumption, ranking of mutually exclusive projects and the potential for multiple IRRs. These errors can lead to bias in the investment decision, particularly when applied to energy investment decisions where mutually exclusive projects with different investment costs and different lifetimes are compared. Almost all renewable energy technologies (RETs) share the characteristics of initial high capital costs followed by a stream of relatively low variable costs over the lifetime of the investment, Read more…

Categories: Academic Papers, Finance and investment

Tags: Biomass investment, conference 2012, European Energy in a Challenging World, IRR, Student poster

Groth-How-the-IRR-drives-bias-in-energy-investment-decisions.pdf*497.86 KB*

Sep

2012