Irr

donnacardwell

Im struggling with internal return rate, can anyone help???

SandyHood

Do you recall this answer to Net Present Value?

Net Present Value
If you look on page 20 of
http://www.aat.org.uk/other_files/ECRJune06questions.pdf

The example shows a new business idea which has costs and revenues each year. The discounting of future cash flows is similar
............................................Year 0..Year1..Year2....Year3


............................................. £000.. £000 .. £000 ....£000
Capital expenditure ................... 600
Other cash flows:..........................................................
Sales income ...................................... 760..... 920..... 1,060
Operating costs .................................. 456...... 542....... 612


So we have annual cash flows of . (600).. 304....... 378....... 448

To find how much these cashflows are worth now we have to discount them (as we did in the NPC example)
Present values ......................... (600)... 267....... 291....... 302

And if you add up all these present values the total is the Net Present Value: £260,000 (or unrounded £259,912)



In that response we found that when we applied a 14% cost of capital the Net Present Value was £260,000

IRR asks what % cost of capital would produce a Net Present Value of Zero

We know that the higher the interest rates are the harder it is to make money so the % rate must be more than 14% because we had a posiotive NPV at 14%.

For ECR you do not need to carry out the calculation to find the IRR, so don't worry
But for completeness here is my answer
at 36.7% you would have an NPV = to virtually zero

so the IRR of the machine is 36.7%

Businesses will typically have a hurdle rate for investments. If the 36.7% IRR exceeds the company hurdle rate then this is a worthwhile investment.

sandy.hood@chichester.ac.uk