The internal rate of return (IRR) is the interest rate where the present value of future cash inflows from a project equals the present value of the cash outflows. It can be calculated by dividing the net investment by the annual cash flow. Then using a present value table to find the corresponding interest rate. While the IRR calculation seems simple, in practice it may require trial and error or computer/financial calculator to determine the exact IRR. The IRR is then used to evaluate projects, with those having higher IRRs preferred to those with lower IRRs, all else being equal.

1. Internal Rate of
Return (IRR)

2. 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.

3. Calculating the
Internal Rate of
Return

4. 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.

5. Whoa! I never thoughtI would
say this - but could I see thatin
equationform?
I surely mustbe losingit!

6. Calculating the IRR
Net Investment in Project
---------------------------------- = PV Factor
Annual Cash Flows
379,100
-------------- = 3.791
$100,000
Present
Value
Factor

7. 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.

8. This is
the IRR

9. Wow! Is it always thateasy?
Surely there mustbe a fly in the
ointment.

10. Calculating the IRR . . .
• Use computer
• Use financial calculator
• Use trial and error

11. Trial and Error . . .
Try a discount
rate and
calculate the
NPV of the
project using
that rate.

12. 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.

13. Trial and Error . . .
• If the NPV is greater than zero,
try a higher discount rate.
–Higher rate equals lower NPV.

14. 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

15. Using the IRR . . .
• Projects with higher IRRs are
preferred to projects with lower
IRRs, all other things being equal.