imported>Doug Williamson |
imported>Doug Williamson |
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| (IRR).
| | ISO currency code for the Philippine Peso. |
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| == Definition of IRR == | | == See also == |
| | | * [[COP]] |
| The internal rate of return of a set of cash flows is the [[cost of capital]] which, when applied to discount all of the cash flows (including any initial investment outflow at Time 0) results in a Net Present Value ([[NPV]]) of NIL.
| | * [[ISO currency codes]] |
| | | * [[MXN]] |
| For an investor, the IRR of an investment proposal therefore represents their expected rate of [[return]] on their investment in the project.
| | * [[USD]] |
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| '''Example 1'''
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| A project requires an investment today of $100m, with $110m being receivable one year from now.
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| The IRR of this project is 10%, because that is the cost of capital which results in an NPV of $0, as follows:
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| [[PV]] of Time 0 outflow $100m | |
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| = $(100m)
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| PV of Time 1 inflow $110m
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| = $110m x 1.10<sup>-1</sup>
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| = $100m
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| NPV = - $100m + $100m
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| = '''$0'''.
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| == Determining IRR ==
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| Unless the pattern of cash flows is very simple, it is normally only possible to determine IRR by trial and error (iterative) methods.
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| | | [[Category:The_business_context]] |
| '''Example 2'''
| | [[Category:Cash_management]] |
| | | [[Category:Financial_products_and_markets]] |
| Using straight line interpolation and the following data:
| | [[Category:Liquidity_management]] |
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| First estimated rate of return 5%, positive NPV = $+4m.
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| Second estimated rate of return 6%, negative NPV = $-4m.
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| The straight-line-interpolated estimated IRR is the mid-point between 5% and 6%.
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| This is '''5.5%'''.
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| Using iteration, the straight-line estimation process could then be repeated, using the value of 5.5% to recalculate the NPV, and so on.
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| The IRR function in Excel uses a similar trial and error method.
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| == IRR project analysis decision rule ==
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| In simple IRR project analysis the decision rule would be that:
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| (1) All opportunities with above the required IRR should be accepted.
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| (2) All other opportunities should be rejected.
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| However this assumes the unlimited availability of further capital with no increase in the cost of capital.
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| A more refined decision rule is that:
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| (1) All opportunities with IRRs BELOW the required IRR should still be REJECTED; while
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| (2) All other opportunities remain eligible for further consideration (rather than automatically being accepted).
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| == See also ==
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| * [[CertFMM]]
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| * [[Effective interest rate]]
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| * [[Hurdle rate]]
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| * [[Implied rate of interest]]
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| * [[Interpolation]]
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| * [[Iteration]]
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| * [[Linear interpolation]]
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| * [[Market yield]]
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| * [[Net present value]]
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| * [[Present value]]
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| * [[Shareholder value]]
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| * [[Yield to maturity]]
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