Internal rate of return and Extinguishment: Difference between pages

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''Investment and funding appraisal.''
1.  ''Financial reporting - financial liabilities - International Financial Reporting Standards (IFRS) - IFRS 9.''


(IRR).  
Under IFRS 9 the extinguishment of a financial liability means that the obligation is discharged, cancelled or has expired.


Under paragraph 3.3.2 of IFRS 9 the following changes are accounted for as an extinguishment of the original financial liability:


== Overview of internal rate of return (IRR) ==
:(1) An exchange between an existing borrower and lender of debt instruments
with substantially different terms; or
:(2) A substantial modification of the terms of an existing financial liability or a part of it.


IRR is a percentage summary of the cash flows of a project, for example, an IRR of 10%.


The IRR summarises the timing, as well as the amounts, of the cashflows.
Under paragraph 3.3.3 of IFRS 9, the difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in profit or loss.


This difference may be a modification gain or loss.


For an investor, the IRR of an investment proposal represents their expected rate of [[return]] on their investment in the project.


A greater IRR is normally more attractive for an investor.
:<span style="color:#4B0082">'''''Accounting and tax surprises under IFRS 9'''''</span>


:"Corporate borrowers often need to renegotiate their existing loan liabilities, and in many companies this responsibility will fall on the treasurer.


The IRR is driven by the expected future cash flows from the project.
:Although treasurers may not necessarily be accounting experts, they still need to carefully consider the potential accounting impacts when renegotiating loan terms.  


:Under IFRS 9: Financial Instruments, loan modifications can trigger gains and losses for financial reporting purposes and may even have tax implications."


The IRR of a set of cash flows is:
:''Renegotiating a loan? Get the accounting right - Kern Roberts, managing director, global accounting practice lead Chatham Financial.''


:the [[cost of capital]] which,


:when applied to discount all of the cash flows,
2.  ''Set-off.''


:including any initial investment outflow at Time 0,
A situation in which a claim or demand is set against an opposite claim or demand, reducing or eliminating the first demand.


:results in a [[net present value]] (NPV) of 0.


== See also ==
* [[Derecognition]]
* [[Derivative instrument]]
* [[Fair Value Adjustment]]
* [[Financial instrument]]
* [[Hedge accounting]]
* [[IAS 32]]
* [[IAS 39]]
* [[IFRS 9]]
* [[IFRS 9 hedge accounting reforms: a closer reflection of risk management?]]
* [[IFRS 15]]
* [[Impairment]]
* [[Modification]]
* [[Modification gain or loss]]
* [[Non-substantial modification]]
* [[Recognition]]
* [[Set-off]]
* [[Substantial modification]]


<span style="color:#4B0082">'''Example 1: IRR - single period 10%'''</span>
A project requires an investment today of $100m, with $110m being receivable one year from now.
The IRR of this project is 10%, because that is the cost of capital which results in an NPV of $0, as follows:
[[PV]] of Time 0 outflow $100m
= $(100m)
PV of Time 1 inflow $110m
= $110m x 1.10<sup>-1</sup>
= $100m


==Other resources==
*[https://www.iasplus.com/en/standards/ifrs/ifrs9 IFRS 9 summary - IAS Plus]
*[https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2022/issued/part-a/ifrs-9-financial-instruments.pdf?bypass=on IFRS 9 full text - IFRS webpage]
*[https://www.treasurers.org/hub/treasurer-magazine/renegotiating-loan-get-accounting-right-warns-adviser Renegotiating a loan? Get the accounting right - Kern Roberts, managing director, global accounting practice lead Chatham Financial]


NPV = - $100m + $100m
[[Category:Accounting,_tax_and_regulation]]
 
[[Category:Corporate_finance]]
= '''$0'''.
[[Category:Corporate_financial_management]]
 
[[Category:Financial_management]]
 
[[Category:Financial_products_and_markets]]
<span style="color:#4B0082">'''Example 2: IRR - single period 5%'''</span>
[[Category:Financial_risk_management]]
 
[[Category:Long_term_funding]]
A project requires an investment today of $100m, with $105m being receivable one year from now.
[[Category:The_business_context]]
 
The IRR of this project is 5%, because that is the cost of capital which results in an NPV of $0, as follows:
 
 
[[PV]] of Time 0 outflow $100m
 
= $(100m)
 
 
PV of Time 1 inflow $105m
 
= $105m x 1.05<sup>-1</sup>
 
= $100m
 
 
NPV = - $100m + $100m
 
= '''$0'''.
 
 
<span style="color:#4B0082">'''Example 3: IRR - two periods 5%'''</span>
 
A project requires an investment today of $100m, with $5m being receivable one year from now, and $105m two years from now.
 
The IRR of this project is 5%, because that is the cost of capital which results in an NPV of $0, as follows:
 
 
[[PV]] of Time 0 outflow $100m
 
= $(100m)
 
 
PV of Time 1 inflow $5m
 
= $5m x 1.05<sup>-1</sup>
 
= $4.76m
 
 
PV of Time 2 inflow $105m
 
= $105m x 1.05<sup>-2</sup>
 
= $95.24m
 
 
NPV = - $100m + $4.76m + $95.24m
 
= '''$0'''.
 
 
<span style="color:#4B0082">'''Example 4: IRR - three periods 5%'''</span>
 
A project requires an investment today of $100m, with $5m being receivable one year from now, a further $5m two years from now, and $105m three years from now.
 
The IRR of this project is 5%, because that is the cost of capital which results in an NPV of $0, as follows:
 
 
[[PV]] of Time 0 outflow $100m
 
= $(100m)
 
 
PV of Time 1 inflow $5m
 
= $5m x 1.05<sup>-1</sup>
 
= $4.76m
 
 
PV of Time 2 inflow $5m
 
= $5m x 1.05<sup>-2</sup>
 
= $4.54m
 
 
PV of Time 3 inflow $105m
 
= $105m x 1.05<sup>-3</sup>
 
= $90.70m
 
 
NPV = - $100m + $4.76m + $4.54m + $90.70m
 
= '''$0'''.
 
 
== Project decision making with IRR ==
 
 
Target or required IRRs are set based on the investor's [[weighted average cost of capital]], appropriately adjusted for the risk of the proposal under review.
 
In very simple IRR project analysis the decision rule would be that:
 
(1) All opportunities with above the required IRR should be accepted.
 
(2) All other opportunities should be rejected.
 
 
However this assumes the unlimited availability of further capital with no increase in the cost of capital.
 
 
A more refined decision rule is that:
 
(1) All opportunities with IRRs BELOW the required IRR should still be REJECTED; while
 
(2) All other opportunities remain eligible for further consideration (rather than automatically being accepted).
 
 
== Excel's =IRR() function ==
 
Excel's =IRR() function returns the IRR for a block of cells within a single row or column, specified as a range.
 
 
<span style="color:#4B0082">'''Example 5: =IRR() function'''</span>
 
Cell A1 contains -100.
 
Cell A2 contains 110.
 
=IRR(A1:A2)
 
will return '''10%'''.
 
(This is the result we saw in Example 1 above.)
 
 
== Determining IRR manually ==
 
Unless the pattern of cash flows is very simple, it is normally only possible to determine IRR manually by trial and error (iterative) methods.
 
 
<span style="color:#4B0082">'''Example 6: Straight line interpolation'''</span>
 
Using straight line interpolation and the following data:
 
First estimated rate of return 5%, positive NPV = $+4m.
 
Second estimated rate of return 6%, negative NPV = $-4m.
 
The straight-line-interpolated estimated IRR is the mid-point between 5% and 6%.
 
This is '''5.5%'''.
 
 
Using iteration, the straight-line estimation process could then be repeated, using the value of 5.5% to recalculate the NPV, and so on.
 
The IRR function in Excel uses a similar trial and error method.
 
 
== See also ==
* [[Discounted cash flow]]
* [[Effective interest rate]]
* [[Hurdle rate]]
* [[IBR]]
* [[Implied rate of interest]]
* [[Interpolation]]
* [[Investment appraisal]]
* [[IRI]]
* [[Iteration]]
* [[Linear interpolation]]
* [[Market yield]]
* [[Net present value]]
* [[Present value]]
* [[Return on investment]]
* [[Shareholder value]]
* [[Time value of money]]
* [[Weighted average cost of capital]]
* [[Yield to maturity]]
 
[[Category:Investment]]
[[Category:Cash_management]]

Revision as of 21:29, 30 October 2024

1. Financial reporting - financial liabilities - International Financial Reporting Standards (IFRS) - IFRS 9.

Under IFRS 9 the extinguishment of a financial liability means that the obligation is discharged, cancelled or has expired.

Under paragraph 3.3.2 of IFRS 9 the following changes are accounted for as an extinguishment of the original financial liability:

(1) An exchange between an existing borrower and lender of debt instruments

with substantially different terms; or

(2) A substantial modification of the terms of an existing financial liability or a part of it.


Under paragraph 3.3.3 of IFRS 9, the difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in profit or loss.

This difference may be a modification gain or loss.


Accounting and tax surprises under IFRS 9
"Corporate borrowers often need to renegotiate their existing loan liabilities, and in many companies this responsibility will fall on the treasurer.
Although treasurers may not necessarily be accounting experts, they still need to carefully consider the potential accounting impacts when renegotiating loan terms.
Under IFRS 9: Financial Instruments, loan modifications can trigger gains and losses for financial reporting purposes and may even have tax implications."
Renegotiating a loan? Get the accounting right - Kern Roberts, managing director, global accounting practice lead Chatham Financial.


2. Set-off.

A situation in which a claim or demand is set against an opposite claim or demand, reducing or eliminating the first demand.


See also


Other resources

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