Question

If a property&#x27;s Internal Rate of Return (IRR) is lower than the required discount rate, what is the mathematical effect on the Net Present Value (NPV) of that investment?

Accepted Answer

If a property&#x27;s Internal Rate of Return is lower than the required discount rate, the resulting Net Present Value will be negative. The Net Present Value is the total current value of all future cash flows from an investment, minus the initial cost of that investment. The Internal Rate of Return is the specific discount rate that makes the Net Present Value exactly zero. A required discount rate represents the minimum annual return an investor demands to justify the risk of the project. Because the Net Present Value function is inversely related to the discount rate, using a discount rate higher than the Internal Rate of Return mathematically forces the present value of future cash inflows below the value of the initial investment. For example, if a project has an Internal Rate of Return of 8 percent and you require a 10 percent return, discounting the cash flows at 10 percent will result in a negative Net Present Value, indicating that the investment does not meet your minimum return threshold.

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If a property's Internal Rate of Return (IRR) is lower than the required discount rate, what is the mathematical effect on the Net Present Value (NPV) of that investment?