Internal Rate of

Return (IRR)
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
Present
379,100 Value
-------------- = 3.791 Factor
$100,000
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 < RRR ==>Reject
Using the IRR . . .
Projects with higher IRRs are
preferred to projects with lower
IRRs, all other things being equal.