5F.3
3. Why is it a bad idea to use IRR to
choose between projects? [5]
Since IRR is only a rate of return, and does not measure actual value created or destroyed, it is a very poor tool for choosing between projects. One project may have a very high rate of return, but not create much value (like a 1000% return on a $100 investment) while another project may have a lower, but still acceptable, rate of return and create much more value (like a 15% return on $1M). If you can only undertake one project, you should choose the one that creates the most value. Also, the timing and relative size of the cash flows have to be exactly the same between the two projects in order for the IRR to always choose the right project.