Question

Internal Rate of Return Method

The internal rate of return (IRR) method uses present value concepts to compute the rate of return from a capital investment proposal based on its expected net cash flows. This method, sometimes called the time-adjusted rate of return method, starts with the proposal's net cash flows and works backward to estimate the proposal's expected rate of return.

Let's look at an example of internal rate of return calculation with even cash flows.

A company has a project with a 5-year life, requiring an initial investment of $211,600, and is expected to yield annual cash flows of $53,000. What is the internal rate of return?

IRR Factora	=	Investmentb
		Annual cash flowsc

^aIRR Factor: This is the factor which you’ll use on the table for the present value of an annuity of $1 dollar in order to find the percentage which corresponds to the internal rate of return.

^bInvestment: This is the present value of cash outflows associated with a project. If all of the investment is up front at the beginning of the project, the present value factor is 1.000.

^cAnnual Cash Flows: This is the amount of cash flows to be received annually as a result of the project.

Calculation Steps

Present Value of an Annuity of $1 at Compound Interest.

IRR Factor =	$	= , rounded to 6 decimals
	$

The calculated factor corresponds to which percentage in the present value of ordinary annuity table?

%

Answer 1

IRR= 8%

The factor 3.99245 calculated corresponds to 8% in the present value of ordinary annuity at n=5.