IRR (Internal Rate of Return)

Edspira2 minutes read

IRR is a method for project evaluation, similar to NPV, determining the discount rate that makes the NPV zero to decide on project acceptance based on a break-even point. In a project example, calculating an IRR of 30% compared to the original 8% discount rate indicates project acceptance if the calculated Big R exceeds the original discount rate.

Insights

  • IRR is a method that calculates the discount rate at which a project's Net Present Value becomes zero, indicating the break-even point and providing a decision rule for project acceptance based on whether this rate exceeds the original discount rate.
  • In contrast to NPV, IRR focuses on identifying the specific discount rate that aligns with a project's financial viability, offering a unique perspective on evaluating investment opportunities beyond traditional methods like NPV.

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Recent questions

  • What is Internal Rate of Return (IRR)?

    IRR is a method to evaluate projects.

  • How does IRR differ from NPV?

    IRR involves setting NPV to zero.

  • What is the decision rule for IRR?

    Accept project if Big R exceeds original discount rate.

  • How is IRR calculated in projects?

    IRR determines discount rate making NPV zero.

  • What does a positive NPV indicate?

    Positive NPV indicates project acceptance.

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Summary

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Evaluating Projects with Internal Rate of Return

  • Internal Rate of Return (IRR) is a method to evaluate projects for decision-making, similar to Net Present Value (NPV).
  • In a project example, investing $100 at year zero and receiving $130 at year one, the NPV calculation with an 8% discount rate yields a positive $20.37, indicating project acceptance.
  • Contrasting with NPV, IRR involves setting the NPV to zero and solving for a different discount rate (Big R), which in this case is 30%, compared to the original 8% (little r).
  • IRR determines the discount rate that makes the NPV zero, serving as a break-even point, with a decision rule of accepting the project if the calculated Big R exceeds the original discount rate.
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