i read some where that if the markets are efficient irr represents the required return
what does the markets are efficient mean here
IRR is a plug in number that gives you the minimum required return, or an NPV of zero. Efficent markets are meaningless here since we are solving for the project itself, internally, and not compared to the “market”.
Unless the statement tries to say that in an efficent market, cash flows are certain due to availability of information, in which case, we tend to assume all information is present, and cash flows are the expected cash flows for each period. So it becomes an exercise of projecting errors that ultimately leads to an incorrect IRR, but that should not be part of the curriculum AFAIR.
Mr. Smart, you nailed it on the head. If i remember correctly, this was in one of the introductory chapters for Equity.
My interpretation of this statement basically states that in an efficient market, where all information is known and we’re 100% certain that we will receive x amount of dividends/CF over time, the price today reflects those expecations. Today’s price, or value, is based on expectations of future cash flow and because we have all the relevant information, the appropriate discount rate (required rate of return) would factor in these known expecations.
Taking an application from CF, if you were to buy the stock at today’s price and use the price as an inital cash outflow, then compute the known dividends received overtime as subsquent cash inflows, using the discount rate (based on known information) you should get an NPV of 0. IRR is the rate that would also produce an NPV of 0, thus they would be the same.
Required return is a function of risk. In an efficient market information flows perflectly to all agents so market prices correctly reflect intrinsic value. Since prices are the present value of future cash flows, the implied risk premiums all sum exactly the required rate of return.