Unconventional Cash Flow

Key takeaways
* An unconventional cash flow has more than one change in sign (inflows and outflows switch direction multiple times) over a project’s life.
* Such cash flows can produce multiple internal rates of return (IRRs), creating ambiguity in IRR-based decisions.
* Use NPV, the modified internal rate of return (MIRR), or NPV profiles and sensitivity analysis to evaluate projects with unconventional cash flows.

What it means

An unconventional cash flow sequence alternates between negative (outflow) and positive (inflow) amounts more than once. For example:
* -, +, +, +, -, +
* +, -, -, +, -, –

Most capital projects, by contrast, have a conventional pattern: an initial outflow (investment) followed by a series of inflows (revenues).

Why it matters for capital budgeting

Capital-budgeting tools rely on predictable cash-flow patterns:

• NPV (net present value) discounts future cash flows to a single present value and produces an unambiguous decision rule: accept if NPV > 0.
• IRR finds the discount rate that makes NPV = 0. For conventional cash flows, IRR is unique and easy to compare to a hurdle rate.
• For unconventional cash flows, the NPV equation can yield multiple positive IRRs (the number of possible positive roots can be up to the number of sign changes). Multiple IRRs create decision uncertainty because different IRRs may lead to conflicting accept/reject signals when compared to a single hurdle rate.

Example consequence: if a project’s IRRs are 5% and 15% but your company’s hurdle rate is 10%, the IRR method gives no clear answer.

Common real-world sources

Unconventional patterns often arise in long-term or large projects that require intermittent major expenditures, such as:
* Construction followed by long operating periods and scheduled large maintenance expenditures.
* Projects with large decommissioning or remediation costs near the end of life.
* Investments that receive subsidies, refunds, or penalties at irregular times.

How to evaluate projects with unconventional cash flows

When IRR is ambiguous, consider these alternatives:

• Use NPV as the primary decision rule. NPV produces a single, economically grounded metric.
• Use MIRR (modified IRR). MIRR assumes a specific reinvestment rate (commonly the firm’s cost of capital), producing a unique rate that avoids the multiple-IRR problem.
• Plot an NPV profile (NPV vs. discount rate). The profile shows how many times NPV crosses zero and helps visualize sensitivity to discount rate.
• Conduct sensitivity and scenario analysis. Vary key assumptions (discount rate, timing, magnitude of outflows) to see how robust conclusions are.
• Apply incremental analysis for mutually exclusive projects to compare NPVs directly.

Conclusion

Unconventional cash flows complicate IRR-based decisions because they can produce multiple IRRs. The safest approach is to rely on NPV or MIRR, supplemented by NPV profiles and sensitivity analysis, to reach clear, economically consistent investment decisions.