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![Trial & Error Method
(By applying different discount rates)
• 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 + 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 + 235,357
= Rs. - 4,643](https://image.slidesharecdn.com/presentationoninternalrateofreturnirr-240805074619-ed3b7f28/75/Presentation-on-Internal-Rate-of-Return-IRR-5-2048.jpg)
![Where
IRR = internal rate of return
LDR = lower discount rate
HDR = higher discount rate
D = difference between two discount rate
Now,
= 15 + (17-15) × [3,059/{3,059-(-4,643)}]
= 15 + 0.7944
IRR = 15.79 % approx.](https://image.slidesharecdn.com/presentationoninternalrateofreturnirr-240805074619-ed3b7f28/75/Presentation-on-Internal-Rate-of-Return-IRR-7-2048.jpg)
Presentation on Internal Rate of Return (IRR)
- 1. Presentation on InternalRate of Return (IRR) Presented by: Ganesh Raj Joshi Roll.No. 04 GAASC, Baitadi, Nepal
- 2. Introduction • Internal rateof return is a metric used in financial analysis to estimate the profitability of potential investments • IRR is the annual rate of growth that an investment is expected to generate • It is a discount rate which makes its NPV equal to zero • If, IRR is used in financial analysis, it is named as financial rate of return and in economic analysis, it is called economic rate of return
- 3. contd…. • It isactually the earning rate of the project under evaluation • In IRR calculation we set the NPV equal to zero and determine the discount rate that satisfies the condition • It is the value of r in the following equation : Initial investment = t Where, Ct is the cash flow at the end of year t, r is the internal rate of return (IRR), and n is the life of the project
- 4. Calculating IRR (Trial &error method with interpolation formula) Years Cash Flows (Rs.) 1. 140,000 2. 80,000 3. 60,000 4. 20,000 5. 20,000 • 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% • Calculate the IRR for the project
- 5. Trial & ErrorMethod (By applying different discount rates) • 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 + 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 + 235,357 = Rs. - 4,643
- 6. Interpolation Formula • Byusing 15% rate we have a positive figure that is greater than zero whereas by using 17% rate we have a negative figure that is lesser than zero • NPV appears to be zero between 15% and 17% so IRR is somewhere in that range • By using interpolation formula : IRR = LDR + D NPV at LDR NPV at LDR – NPV at HDR
- 7. Where IRR = internalrate of return LDR = lower discount rate HDR = higher discount rate D = difference between two discount rate Now, = 15 + (17-15) × [3,059/{3,059-(-4,643)}] = 15 + 0.7944 IRR = 15.79 % approx.
- 8. Decision criteria In caseof single project : Accept the project when IRR is greater than opportunity cost of capital i.e. market interest rate which is generally between 14- 19% In case of two mutually exclusive projects : Accept one having higher Internal Rate of Return
- 9. Advantage • Consider timevalue of money • Determine exact rate of return • Focus on profitability • Consider all cash flows for the project over the years Disadvantage • It is complex technique • Not suitable to compare between mutually exclusive projects • Result may not match with NPV
- 10.