There are several advantages when it comes to the IRR. But the main aspect is that it provides a need that NPV doesn’t; a rule that summarizes the information of a project in a single rate of return. A big plus is that it takes the TVM into consideration unlike the payback period method. After calculated, it is very simple to interpret and therefor easy to visualize for managers.
The main disadvantage is that the economies of scale are ignored. A project value of £1,000,000 with a 20 percent rate of return would naturally be preferred over a project value of £1,000 with a 40 percent rate of return. But with the latter rank of the IRR method would advise otherwise as 40 percent is more than 20 percent. This problem usually occurs specifically to mutually exclusive projects and can be solved for example using incremental cash flows. A second disadvantage is one that arises when there are conventional cash flows. In those cases the NPV will equal zero more than one time, which will lead to multiple IRRs. In these cases the IRR method simply cannot be used here.
A third disadvantage to the IRR method is that it has impractical implicit of the reinvestment rate. Even though it is rarely the case where a firm has the same reinvestment rate, the IRR method implies this. It continues to assume that the firm will make another investment at the same rate even though that is close to impossible.