imported>Doug Williamson |
imported>Doug Williamson |
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| (IRR).
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| | One unit of the UK pound sterling (GBP). |
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| == Definitions of internal rate of return (IRR) ==
| | For most of the historical period up the early 19th century, it could - in theory - be exchanged for one pound (weight) of silver. |
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| For an investor, the IRR of an investment proposal represents their expected rate of [[return]] on their investment in the project.
| | Thereafter the pound was generally backed by gold (the 'gold standard'). |
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| If the project were funded by borrowing all the required money at the IRR, there would be exactly the right amount of profit from the project to repay the borrowing and interest.
| | Since 1931, the pound sterling has been a fiat currency. |
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| The IRR is driven by the expected future cash flows from the project.
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| The IRR of a set of cash flows is:
| | A pound is also one unit of a number of other currencies including those of Egypt (EGP), Lebanon (LBP), Sudan (SDG) and Syria (SYP). |
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| :the [[cost of capital]] which,
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| :when applied to discount all of the cash flows,
| | == See also == |
| | | * [[Egypt]] |
| :including any initial investment outflow at Time 0,
| | * [[Fiat currency]] |
| | | * [[FKP]] |
| :results in a [[net present value]] (NPV) of 0.
| | * [[GBP]] |
| | * [[GIP]] |
| | * [[Gold standard]] |
| | * [[Libra]] |
| | * [[Lira]] |
| | * [[SHP]] |
| | * [[SSP]] |
| | * [[Sterling]] |
| | * [[United Kingdom]] |
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| | | [[Category:The_business_context]] |
| <span style="color:#4B0082">'''Example 1: IRR'''</span>
| | [[Category:Financial_products_and_markets]] |
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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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| If the project had been funded by borrowing all the required money at the IRR of 10%, there would have been exactly the right amount of profit from the project to repay the borrowing and interest, with neither a deficit nor a surplus.
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| This is another way to define the IRR.
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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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| <span style="color:#4B0082">'''Example 2: Straight line interpolation'''</span>
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| Using straight line interpolation and the following data:
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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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| == Project decision making with IRR ==
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| 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.
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| In very 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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| * [[IBR]]
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| * [[Implied rate of interest]]
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| * [[Interpolation]]
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| * [[IRI]]
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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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| * [[Return on investment]]
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| * [[Shareholder value]]
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| * [[Weighted average cost of capital]]
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| * [[Yield to maturity]]
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1.
One unit of the UK pound sterling (GBP).
For most of the historical period up the early 19th century, it could - in theory - be exchanged for one pound (weight) of silver.
Thereafter the pound was generally backed by gold (the 'gold standard').
Since 1931, the pound sterling has been a fiat currency.
2.
A pound is also one unit of a number of other currencies including those of Egypt (EGP), Lebanon (LBP), Sudan (SDG) and Syria (SYP).
See also
