Presentation on Internal Rate of Return (IRR)

This presentation offers an in-depth exploration of the Internal Rate of Return (IRR), a key financial metric used to evaluate the profitability of potential investments. It is an essential tool for financial analysts, investors, and business professionals involved in project evaluation and investment decision-making.

1. Presentation on Internal Rate of Return (IRR) Presented by: Ganesh Raj Joshi Roll.No . 04 GAASC, Baitadi , Nepal

2. Introduction Internal rate of 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. c ontd …. It is actually 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, C t 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 & 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

6. Interpolation Formula By using 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 = 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.

8. Decision criteria In case of 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 time value 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. Thank you