imported>Doug Williamson |
imported>Doug Williamson |
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| (IRR). | | (SLA). |
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| '''1.'''
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| 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 flow at Time 0) results in a Net Present Value (NPV) of NIL.
| | An SLA formalises the relationship between a bank's customer and its bank, by covering the minimum standards of service expected by the customer - including key performance indicators (KPIs) - and agreed to by the bank. |
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| For an investor, the IRR of an investment proposal therefore represents their expected rate of return on their investment in the project.
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| | SLAs are also used between one bank and another. For example, where a bank provides services to its own customers indirectly, through a correspondent bank. |
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| '''''Example'''''
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| For example, a project requires an investment today of $100m, with $110m being receivable one year from now.
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| | More generally, any similar agreement between a customer and a service provider. |
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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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| | == See also == |
| | * [[Alliance bank]] |
| | * [[Correspondent banking]] |
| | * [[Key performance indicator]] |
| | * [[QA]] |
| | * [[Report card]] |
| | * [[SLA partner banking]] |
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| PV of Time 0 outflow $100m = $(100m)
| | [[Category:Compliance_and_audit]] |
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| PV of Time 1 inflow $110m = $110m x 1.1<sup>-1</sup> = $100m
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| NPV = -$100m + $100m
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| = '''$0'''.
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| '''2.'''
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| It is normally only possible to determine IRR by trial and error (iterative) methods.
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| '''''Example'''''
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| For example, using straight line interpolation and the following data:
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| First estimated rate of return 5%, positive NPV = $+4m; and
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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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| '''3.'''
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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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| * [[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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(SLA).
1.
An SLA formalises the relationship between a bank's customer and its bank, by covering the minimum standards of service expected by the customer - including key performance indicators (KPIs) - and agreed to by the bank.
2.
SLAs are also used between one bank and another. For example, where a bank provides services to its own customers indirectly, through a correspondent bank.
3.
More generally, any similar agreement between a customer and a service provider.
See also
