What Is the Pooled Internal Rate Of Return (PIRR)?

Pooled internal rate of return (PIRR) is a method of calculating the overall internal rate of return (IRR) of a portfolio that consists of several projects by combining their individual cash flows. In order to calculate this, you need to know not only the cash flows received but also the timing of those cash flows. The overall IRR of the portfolio can then be calculated from this pool of cash flows.

The pooled internal rate of return can be expressed as a formula:

IRR = NPV = t=1TCt(1+r)t  C0 = 0where:IRR = internal rate of returnNPV = net present valueCt = the pooled cash flows expected at time t\begin{aligned}&IRR\ =\ NPV\ =\ \sum^T_{t=1}\frac{C_t}{(1+r)^t}\ -\ C_0\ =\ 0\\&\textbf{where:}\\&IRR\ =\ \text{internal rate of return}\\&NPV\ =\ \text{net present value}\\&C_t\ =\ \text{the pooled cash flows expected at time }t\\&r\ =\ \text{the risk-free rate of return}\end{aligned}IRR = NPV = t=1T(1+r)tCt  C0 = 0where:IRR = internal rate of returnNPV = net present valueCt = the pooled cash flows expected at time t

Understanding the Pooled Internal Rate Of Return

The internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does. The pooled IRR is the rate of return at which the discounted cash flows (the net present value) of all projects in the aggregate are equal to zero.

The pooled internal rate of return (PIRR) can be used to find the overall rate of return for an entity running multiple projects or for a portfolio of funds each producing their own rate of return. The pooled IRR concept can be applied, for example, in the case of a private equity group that has several funds. The pooled IRR can establish the overall IRR for the private equity group and is better suited for this purpose than say average IRR of the funds, which may not give an accurate picture of overall performance.

Key Takeaways

  • Pooled IRR (PIRR) is a method for calculating the returns from a number of concurrent projects in which an IRR is calculated from the aggregated cash flows of all the cash flows.
  • The pooled IRR is the rate of return at which the discounted cash flows (the net present value) of all projects in the aggregate are equal to zero.
  • The pooled IRR concept can be applied, for example, in the case of a private equity group that has several funds.

PIRR versus IRR

IRR is most often used when computing the rate of return associated with the expected cash flows of a particular project. In reality, however, a firm may have several concurrent projects for which it must make budget allocation decisions. This syndrome is especially true for private equity firms or venture capital funds that have several investments going on at any given time. While individual IRR calculations can be used to evaluate each individual project, the pooled IRR is better used to understand the internal rate of return for the firm's entire portfolio in aggregate.

Limitations of PIRR

As with IRR, PIRR can be misleading if used in isolation. Depending on the initial investment costs, a pool of projects may have a low IRR but a high NPV, meaning that while the pace at which the company sees returns on a portfolio of projects may be slow, the projects may also be adding a great deal of overall value to the company.

The other issue that is unique to PIRR is that since cash flows are pooled from various projects, it may conceal poorly performing projects and mute the positive effect of lucrative projects. Both individual and pooled IRR should be conducted to identify the existence of any outliers.