INTERNAL RATE OF RETURN (IRR)

MANUAL OF FINANCIAL CONCEPTS

INTERNAL RATE OF RETURN (IRR)

It is the discount rate which makes the NPV equal to cero.

NPV = – A + [ CF1 / (1+r)^1 ] + [ CF2 / (1+r)^2 ] +…+ [ CFn / (1+r)^n ] = 0

If IRR> discount rate (r): The project is acceptable.
If IRR< discount rate (r): The project is not acceptable.

This method is not as reliable as the NPV method. Therefore, it is normally used in addition to the NPV.

Example of calculation of IRR:

If we suppose that in this example the discount rate of the company is 10 % (13%>10%) then, we can say that this project is profitable, because the IRR is higher than the discount rate of the company (normally the wacc).

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