Internal Rate of Return (IRR)

Is the rate of interest at which –The present value of expected cash inflows from a project Equals –The present value of expected cash outflows of the project.

Calculating the Internal Rate of Return

Computing the IRR... The IRR can be calculated by dividing the net investment by the annual cash flow to find the investments present value factor. Then, refer to the Present Value of an Annuity of $1 table to find the corresponding rate.

Whoa! I never thought I would say this - but could I see that in equation form? I surely must be losing it!

Calculating the IRR Net Investment in Project = PV Factor Annual Cash Flows 379, = $100,000 Present Value Factor

Calculating the IRR... To determine the IRR, refer to the Present Value of an Annuity of $1 table for 5 periods; Scan across the line until you find a factor approximating 3.791; The rate at the top of the column is the Internal Rate of Return.

This is the IRR

Wow! Is it always that easy? Surely there must be a fly in the ointment.

Calculating the IRR... Use computer Use financial calculator Use trial and error

Trial and Error... Try a discount rate and calculate the NPV of the project using that rate.

Trial and Error... If the NPV is less than zero, try a lower rate. –A lower rate will increase the NPV. We are looking for the rate that will result in zero NPV.

Trial and Error... If the NPV is greater than zero, try a higher discount rate. –Higher rate equals lower NPV.

Using the IRR... A project is accepted if the internal rate of return exceeds the required rate of return. –If IRR > RRR ==>Accept –If IRR = RRR ==>Accept –If IRR Reject

Using the IRR... Projects with higher IRRs are preferred to projects with lower IRRs, all other things being equal.