Wednesday, December 15, 2010

Internal Rate of Return (IRR)

The internal rate of return (IRR) is the most difficult equation to calculate of all the cash flow techniques. It is a complicated formula and should be performed on a financial calculator or computer. IRR can be figured manually, but it’s a trial-and-error approach to get to the answer.

Technically speaking, IRR is the discount rate when the present value of the cash inflows equals the original investment. When choosing between projects or when choosing alternative methods of doing the project, projects with higher IRR values are generally considered better than projects with low IRR values.

Three facts concerning IRR:
  • IRR is the discount r NN ate when NPV equals zero.
  • IRR assumes that cash inflows are reinvested at the IRR value.
  • You should choose projects with the highest IRR value.

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