The document discusses the internal rate of return (IRR) as a discount rate used in capital budgeting to evaluate project desirability based on cash flows. It provides a case study with an initial outlay of Rs. 240,000 and various cash flows, demonstrating calculation of IRR using trial and error method and interpolation, concluding that the project is feasible since its IRR exceeds the company's required rate of return. It also differentiates between conventional and nonconventional projects in terms of cash flow structures.

1. Internal Rate of Return (IR
Finding IRR is no more difficult now . .

2. ,
leverage
,
concept of leverage
,
types of leverage
,
degree of leverage
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cost associate with leverage
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business risk & dol

3. What is IRR ?
 The discount rate often used in capital budgeting that
makes the net present value of all cash flows from a
particular project equal to zero.
 Generally speaking, the higher a project's internal rate
of return, the more desirable it is to undertake the
project.
 As such, IRR can be used to rank several prospective
projects a firm is considering. Assuming all other
factors are equal among the various projects, the
project with the highest IRR would probably be
considered the best and undertaken first.
 IRR is sometimes referred to as “Economic Rate of

4. FINDING IRR
(Trial & Error Method with Interpolation Formula)
 A project involves an initial
outlay of Rs. 240,000. The
estimated net cash flows
for the project are as given:
 The company’s required
rate of return is 13
percent.
 Calculate the IRR for the
project. Is the project
feasible assuming all other
factors are equal ?
Years
Cash Flows
(Rs.)
1. 140,000
2. 80,000
3. 60,000
4. 20,000
5. 20,000

5. IRR can be calculated by Trial & Error Method:
(By applying different discount rates)
At 13 % discount rate:
NPV = - 240,000+[140,000/(1.13)]+[80,000/(1.13)2]+[60,000/(1.13)3]+[20,000/(1.13)4]+[20,000/(1.13)5]
= - 240,000 + 123,894 + 62,652 + 41,583 + 12,266 + 10,855
= - 240,000 + 251,250
= Rs. 11,250
At 15 % discount rate:
NPV = - 240,000+[140,000/(1.15)]+[80,000/(1.15)2]+[60,000/(1.15)3]+[20,000/(1.15)4]+[20,000/(1.15)5]
= - 240,000 + 121,739 + 60,491 + 39,450 + 11,435 + 9,944
= - 240,000 + 243,059
= Rs. 3,059
At 17 % discount rate:
NPV = - 240,000+[140,000/(1.17)]+[80,000/(1.17)2]+[60,000/(1.17)3]+[20,000/(1.17)4]+[20,000/(1.17)5]
= - 240,000 + 119,658 + 58,441 + 37,463 + 10,673 + 9,122
= - 240,000 + 235,357
= Rs. - 4643

6. INTERPOLATION FORMULA :

7. Now Applying 15.79%, We have NPV
nearer to Zero :
NPV = -240,000+[140,000/(1.1579)]+[80,000/(1.1579)2]
+[60,000/(1.1579)3]+[20,000/(1.1579)4]+[20,000/(1.1579)5]
= - 240,000 + 120,909 + 59,669 + 38,649 + 11,126 +
9,609
= - 240,000 + 239,962
NPV = Rs. 38  Nearer to Zero

8. Project Feasibility :
The project is feasible as its Internal Rate of
Return (IRR) is greater than the company’s
required rate of return, assuming all other
factors are equal*.
*( If there are two mutually exclusive
projects and both have IRR greater than the
company’s required rate of return then the
project with higher NPV will be preferred. In
other words, other capital budgeting
techniques will be employed. )

9. Conventional Vs Nonconventional Project
Conventional:
An initial outflow followed only by a series
of inflows.
Nonconventional:
An initial outflow followed only by a series of
inflows and outflows.