Irr

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

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  • SandyHood
    SandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    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.

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    Sandy
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