internal rate of return

(noun)

IRR. The rate of return on an investment which causes the net present value of all future cash flows to be zero.

Related Terms

Examples of internal rate of return in the following topics:

  • Calculating the IRR

    • Given a collection of pairs (time, cash flow), a rate of return for which the net present value is zero is an internal rate of return.
    • Given a collection of pairs (time, cash flow) involved in a project, the internal rate of return follows from the net present value as a function of the rate of return.
    • A rate of return for which this function is zero is an internal rate of return.
    • Given the (period, cash flow) pairs (n, Cn) where n is a positive integer, the total number of periods N, and the net present value NPV, the internal rate of return is given by r in:
    • Because the internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero, then the IRR r is given by the formula:

  • Advantages of the IRR Method

    • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investment.
    • In other words, an investment is considered acceptable if its internal rate of return is greater than an established minimum acceptable rate of return or cost of capital.
    • In addition, the internal rate of return is a rate quantity, it is an indicator of the efficiency, quality, or yield of an investment.
    • Internal rate of return is the rate at which the NPV of an investment equals 0.
    • Describe the advantages of using the internal rate of return over other types of capital budgeting methods

  • Calculating the Yield of an Annuity

    • The yield of an annuity is commonly found using either the percent change in the value from PV to FV, or the internal rate of return.
    • The second popular method is called the internal rate of return (IRR).
    • The IRR is the interest rate (or discount rate) that causes the Net Present Value (NPV) of the annuity to equal 0.
    • This investment has an implicit rate of return, but you don't know what it is.
    • Calculate the yield of an annuity using the internal rate of return method

  • Multiple IRRs

    • In a series of cash flows like (−10, 21, −11), one initially invests money, so a high rate of return is best, but then receives more than one possesses, so then one owes money, so now a low rate of return is best.
    • Accordingly, Modified Internal Rate of Return (MIRR) is used, which has an assumed reinvestment rate, usually equal to the project's cost of capital.
    • It has been shown that with multiple internal rates of return, the IRR approach can still be interpreted in a way that is consistent with the present value approach provided that the underlying investment stream is correctly identified as net investment or net borrowing.
    • Apparently, managers find it easier to compare investments of different sizes in terms of percentage rates of return than by dollars of NPV.
    • Explain the best way to evaluate a project that has multiple internal rates of return

  • Defining the IRR

    • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.
    • It is also called the "discounted cash flow rate of return" (DCFROR) or the rate of return (ROR).
    • In the context of savings and loans the IRR is also called the "effective interest rate. " The term "internal" refers to the fact that its calculation does not incorporate environmental factors (e.g., the interest rate or inflation).
    • The internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value (NPV as NET*1/(1+IRR)^year) of all cash flows (both positive and negative) from a particular investment equal to zero.
    • Explain how Internal Rate of Return is used in capital budgeting

  • Percentage Returns

    • This type of return is also called the return on investment (ROI), where the numerator is the dollar return.
    • This is the arithmetic mean of the return.
    • CAGR is a way of measuring the return per year.
    • It is widely used because it allows for the easy comparison of the growth rates of multiple investments.
    • Another common method for finding the annual return is to calculate the internal rate of return (IRR).

  • Calculating and Understanding Average Returns

    • The average return of an investment can be calculated a number of ways.
    • To calculate the total ROI of an investment, simply divide the total dollar returns of the investment by the initial value.
    • Average ROI generally does not calculate the actual average rate of return, because it does not incorporate compounding returns.
    • CAGR is very useful for finding the rate of return that the investment would have to earn every year for the life of the investment to turn the initial value into the future value over the given time frame.
    • The internal rate of return (IRR) is another commonly used method for calculating the average return .

  • Assessing Internal Growth and Sustainability

    • Sustainable-- as opposed to internal-- growth gives a company a better idea of its growth rate while keeping in line with financial policy.
    • We find the internal growth rate by dividing net income by the amount of total assets (or finding return on assets) and subtracting the rate of earnings retention.
    • We find the sustainable growth rate by dividing net income by shareholder equity (or finding return on equity) and subtracting the rate of earnings retention.
    • While the internal growth rate assumes no financing, the sustainable growth rate assumes you will make some use of outside financing that will be consistent with whatever financial policy being followed.
    • The study found that return on assets, return on sales and return on equity do in fact rise with increasing revenue growth of between 10% to 25%, and then fall with further increasing revenue growth rates.

  • Relationships between ROA, ROE, and Growth

    • Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
    • What is the company's ROA and internal growth rate?
    • In review, return on equity measures the rate of return on the ownership interest (shareholders' equity) of common stockholders.
    • In terms of growth rates, we use the value known as return on assets to determine a company's internal growth rate.
    • Discuss the different uses of the Return on Assets and Return on Assets ratios

  • International Fisher Effect

    • For instance, international investors should earn comparable returns in foreign countries as compared to their home country after we adjust their returns to a currency's exchange rate.
    • Domestic nominal interest rate in APR is id, while rd represents the domestic rate of return of the investment in T days.
    • Thus, both the foreign interest rate and change of currency exchange rate determine an investor's real return.
    • Consequently, arbitrage drives the rate of returns together.
    • Then we set Equations 17 and 18 equal to each other because international arbitrage causes both investment returns to converge to the same rate, shown in Equation 19.