When evaluating a project, if the IRR is less than the required rate of return, what should the manager do?

When evaluating a project, the internal rate of return (IRR) serves as a critical metric for decision-making. The IRR is the discount rate that makes the net present value (NPV) of the project’s cash flows equal to zero. If the IRR of a project is lower than the required rate of return, it indicates that the project is expected to generate returns that do not meet the minimum return threshold set by the firm.

Accepting a project with an IRR below the required rate of return would imply a potential loss of value for the firm, as the project is expected to underperform compared to other investment opportunities with a higher return. In the context of capital budgeting and financial decision-making, this is essential for ensuring that resources are allocated efficiently to projects that will maximize shareholder wealth.

Consequently, rejecting projects with an IRR that is less than the required return is a sound financial strategy, as it helps to ensure that the organization prioritizes only those projects that are likely to create value and contribute positively to its overall financial health. This approach aligns with the fundamental principle of maximizing shareholder value, which is a primary goal of financial management.