Question

1. Suppose you’re developing an office building for a business that will eventually occupy the space themselves. In this project, you’re acting as a fee developer (meaning you will put no equity into the project and your compensation will come as a fee paid by the client). The project will take 4 years to complete. You’ll receive an up-front fee of $250,000 when you start the project, and a completion bonus of $150,000 when the project is delivered to the client. Briefly, explain why calculating the Internal Rate of Return (IRR) is not an effective way to assess your return from this project.

Answer 1

The internal rate of return (IRR) is used to measure and compare the profitability of various business projects and investments. The IRR is a common measurement used by business leaders to decide which projects will yield the greatest results in the form of return on investments.

Let's say a company has three separate projects to evaluate, and the business leaders of the company don't know which project will yield the highest profit. Each project has the same cost of capital (financing costs), so the higher the IRR for the project, the more profitable the project will be, assuming all other risks and factors are equal. Business leaders will only accept a project if the IRR is above the cost of capital for the project, and they'll reject the project if the IRR is below the cost of capital.

In the given Project calculating the Internal Rate of Return (IRR) is not an effective way to assess return Since the developer will put no equity into the project and compensation will come as a fee paid by the client. hence IRR cannot be calculated.