The marginal internal rate of return , or IRR, applies to many types of projects, from building projects to investment buying and selling decisions. The underlying idea is the same -- the marginal IRR is that return obtained from gaining one more unit of value than you possess currently. For example, an investor could compare the marginal IRR gained from selling an investment after two years versus selling it after just one year.
1. Choose an investment, such as an individual stock, to use for your marginal IRR analysis, and obtain the rate of return for that investment, based on a specific holding period and selling it at a certain point in time.
2. Choose an alternate timeline in which to sell the Investment, such as 12 months later than the original selling date chosen in Step 1.
3. Calculate the incremental amount of cash the investment could generate by holding it for one more year. The marginal IRR is the measure of how much more cash flow the investor receives by selling the investment in year 2 instead of year 1.
4. Divide the cash received if selling the investment in Year 2, less the cash received from selling in Year 1, by the Year 1 cash proceeds. This result is the marginal IRR, or the percentage the investor receives from holding his investment for one additional year.
- Make sure to factor in qualitative information. One of the shortcomings of the marginal IRR calculation is that the formula does not factor in the additional investment risk associated with holding an investment for one additional year.
- University of Washington: Investment Decision Making
- The Dow Jones-Irwin Guide to Calculating Yields; Lawrence R. Rosen
- New York University: Many Happy Returns
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