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Internal Rate of Return

Internal rate of return (IRR) is the interest rate that makes the net present value of an investment equal to zero. IRR is calculated by setting the present value of cash inflows equal to the present value of cash outflows and solving for the discount rate. There are five equations that can be used to calculate IRR by relating costs and benefits with IRR as the unknown variable.

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33 views

Internal Rate of Return

Internal rate of return (IRR) is the interest rate that makes the net present value of an investment equal to zero. IRR is calculated by setting the present value of cash inflows equal to the present value of cash outflows and solving for the discount rate. There are five equations that can be used to calculate IRR by relating costs and benefits with IRR as the unknown variable.

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favou5
Copyright
© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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Internal rate of return

Internal rate of return is defined as the interest rate paid on the unpaid balance of
a loan such that the payment schedule makes the unpaid loan balance equal to zero
when the final payment is made.
Internal rate of return is the interest rate eamed on the unrecovered investment such
that the payment schedule makes the unrecovered investment equal to zero at the end
of the life of the investment.

Althoughthetwodefinitionsofinternalrateofreturnarestateddifferently,oneinterms .
of a loan and the other in terms of an investment, there is only one fundamental concept
being described. It is that the int~rnal rate of return is the interest rate at which the
benefits are equivalent to the costs or the present worth (PW)is O.Sincewe are describing
situations of funds that remain within the investment throughout its life, the resulting rate
of return is described as the internal rate of return, i.
To calculate a rate of return on an investment,we must convert the various consequences
of the investment into a cash flow. Then we will solve the cash flow for the unknown
value of the internal rate of return (IRR). Five forms of the cash flow equation are as
follows:

Where EUAB=Equivalent unifonn annual benefit


And
EUAC =Equivalent unifonn annual cost

The five equations represent the same concept in different forms.They can relate costs and
benefits with the IRR as the only unknown.

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