IRR
Concept
IRR stands for internal
rate of return. It is the minimum acceptable rate of return for the
organization. It means organization is ready to accept that rate of return.
This rate of return is compared with the expected rate of return for investment
decision.
1. IRR is average Investment Rate
More
technically irr is the average investment rate for a project. This is the rate
which is accepted by the entity for its investment being the average rate for
investment.
2. NPV is Zero
NPV
calculated on the bases of IRR (internal rate of return) is zero. In simple
term irr is a acceptable rate of return at which net present value becomes
zero.
IRR
Decision Rule
1.
IRR > Desired Rate of return ( project
is accepted)
2.
IRR < Desired Rate of return ( project
is rejected)
It is important to note
that IRR is expected or acceptable rate of return for the organization,
therefore if acceptable rate is higher than desired rate of return, then
project is accepted. For example expected rate is 12%, while desired rate of
return is 10%, and then project is accepted, because you are receiving more
than your desired.
IRR
Calculation
IRR is calculated with the
help of interpolation formula; this formula has been explained below; it is
important to remember that this formula does not calculate IRR exactly, rather
it is an estimated rate, and however, this rate is quite acceptable by the
finance manager.
L+ (Vl/Vl-Vh) (H-L)
L= Lower rate of Return
H= Higher Rate of Return
VL = NPV with Lower rate
of Return
Vh= NPV at higher rate of
return
