Internal Rate of Return (IRR) Examples

Definition: The Internal Rate of Return (IRR) method is used in capital budgeting to compare the profitability of investments. It is also known as the discounted cash flow rate of return (DCFROR) or the rate of return (ROR). IRR is the discount rate that gives a net present value of zero.

Formula:
IRR = lower discount rate + (NPV at lower % rate / distance between 2 NPV) * (Higher % rate - Lower % rate)

Example 1:
A project is expected to have a net present value of $865 at a discount rate of 20% and a negative NPV of $1,040 at a discount rate of 22%. Calculate the IRR.
Solution:
Distance between 2 NPV = 865 + 1040 = $1,905
IRR = 20% + (865 / 1905) * (22% - 20%) = 20.91%

Example 2:
The following information relates to Venture Ltd investment project:
Net Present Value (NPV) at 25% cost of capital: $1,714
NPV at 30% cost of capital: ($2,937)
Calculate the Internal Rate of Return.
Solution:
Distance between 2 NPV = 1714 + 2937 = $4,651
IRR = 25% +  (1714 / 4651) * (30% - 25%) = 26.84%

* Next: Advantages & Disadvantages of IRR
1 comments:
QAMAR 9:21 AM

Consider an investment that costs $100,000 and has a cash inflow of $25,000 every year for 5 years. The required return is 9%, and required payback is 4 years.
What is the payback period?
What is the discounted payback period?
What is the NPV?
What is the IRR?
Should we accept the project?
What decision rule should be the primary decision method?
When is the IRR rule unreliable?