Internal Rate of Return

Internal rate of return is very advance method of capital budgeting and it is based on time value of money. Like NPV and P.I., we also calculate the present value of cash inflows and cash outflows in this method. But this method is purely different from NPV and PI. Before understanding this method of evaluation of investment projects , you should know what is internal rate of return.

Definition of Internal Rate of Return

If you have read the books of financial management of MBA or B.Com. class, you can give the definition of internal rate of return. Like other writers, I can also write that internal rate of return is the rate at which the present value of all cash inflows is equal to the present value of all cash outflows. After finding internal rate of return, we will accept that investment project whose internal rate will high or if there is only one project, then we will compare it with the minimum rate of return. If internal rate of return is more than cut off or minimum rate, then we will accept that single project.

Simplest  Steps of Calculating Internal Rate of Return

Situation No. 1

When cash inflows are equal to the life of asset

First Step

If any asset will give equal return, then you can easily calculate present value factor by dividing initial cash outflow with the annual cash inflow.

Present Value Factor = Initial Investment cost / annual cash flow

Suppose initial investment cost = Rs. 50000
Life of the asset = 5 years

Estimated annual cash flow = Rs. 12500

Present Value factor = 50000/12500 = 4

Second Step

Then we will see present value annuity table and with this we can find the value of IRR.

As we see from the present value annuity table that 8% for 5 years period, the present value is 3.99 or approximately 4

So, internal rate of return is 8%

We will compare this rate with cut off or minimum standard rate of return and if this rate is more than minimum rate then this proposal will be accepted.

Situation No. 2

When the annual cash flows are unequal over the life of the assets and present value of cash inflows and cash outflows will equal at specific rate :-

Second situation is fully on the basis of hit and trial. This situation is like experiment in laboratory. Very few people know, I had worked in chemical science laboratory, where my boss scientist always made some mixture for invention and he ordered me to mix chemical and 90% his experiment failed but he did not loose his confidence. Like this, finance manager has to assume the rate. Suppose it may be 5%, 6% or more and then he has to find factor value of this rate and multiply it with the actual value of cash inflows and cash outflows. If both are equal at specific rate that that rate will be internal rate of return.

Situation No. 3

When the annual cash flows are unequal over the life of the assets and present value of cash inflows and cash outflows will equal between two rates :-

There is minimum chance of second situation where net present value will be zero. Some time present value of cash inflows may excess from present value of cash outflow or sometime cash outflow may excess from cash inflows, then we will calculate internal rate of return on the following simple formula

In this formula we can also take the difference of PV at lower rate and Pv at higher rate. Both will give same answer.

I have solved following question in screencast which also shows the steps of Situation No. 3


Comments on this Website: 1
Share above Content to Your Friends


access account accountant Accounting accounting definitions accounting ebook Accounting education accounting procedure accounting process outsourcing Accounting Software advance advertising africa Amalgamation amendments announcements Annuity assets audit auditing Australia B.Com. balance sheet bank Bank reconciliation banking basic accounting BBA benefits best bill black money blog bloggers book keeping bookkeeping Branch Accounting - full tutorial budget Budget variance business businessman CA calculator canada capital capital budgeting career cash cash book cash flow statement Chiense children china class coaching coins college commerce commerce students company computer computer accounting conference Contact vinod kumar corporate accounting cost cost accounting cost center cost centre CPA credit credit card cs currency data Debit and credit debit cards debt debtor degree depletion depreciation documents dollar domain Downloads Dubai e-accounting earning education Education Loans email employee EPF ERP euromoney examination excel excise duty expenses facebook factor of loan fans feature fifo FII fiji finacle finance Financial financial accounting fire insurance flickr flow forensic forex formula france fraud free fun function fund GAAP GDP gdr germany gold goodwill goodwill accounting google google apps google apps google base google buzz google calendar Google docs google finance google fusion tables google talk govt. GST guide health Hindi Hindi Language history holding company How to treat FBT in Tally 9 HRA ICAI ICAWI ICICI Bank IFRS income income statement Income Tax India indian railway Indonesia inflation inflation accounting infographics information inspiration insurance insurance accounting interest international Internet Introduction of Tally 9 inventory investment invoice IT Japan Job costing journal entries Kalculate keyboard kindle kuwait laptop law LBT learning lease lecture ledger leducation Leverage Analysis liabilities lifo linkedin loan logical point loss loss of profit M.Com. m.phil malaysia management accounting manual accounting manufacturing account market marketing mastercard material MBA MCA media migration mobile money ms word ms. excel multi currency in tally 9 Multicurrency Accounting mutual fund national security new and sacrifice ratio new york times new zealand news NGO nonprofit-accounting North Georgia Mountains NPV NSE odbc office oman online application online accounting otcei pakistan parents pay pal pdf pie chart pie chart of income pnb podcast ppf presentation price privacy policy prize money prof. vinod kumar profit profit and loss account project management provision purchase puzzles quickbooks Quote quotes quotes of svtuition rating agency ratio analysis RBI readers real estate rectification of errors remote control reports reserves responsibility accounting retirement revenue Revenue reserves review risk rupees salary sale saudi arabia saving sbi scholarship school SEBI security service tax share share trading Shares shri lanka singapore sms social accounting society solution South Africa stock stock exchange structure student students study subsidiary company svtuition swiss bank tally tally 9 Tally 7.2 Tally 9 Tally.ERP 9 tanzania tax Tax Accounting TDS teacher teaching technology test testimonial testimonials thailand tips trading trading on equity transaction trend trial balance tuition twitter UAE UGC - NET Commerce UK United Arab Emirates university usa valuation VAT Video Voucher and vouching wikipedia working capital youtube
Accounting Education: Internal Rate of Return
Internal Rate of Return
Accounting Education
Not found any lecture VIEW ALL Readmore Reply Cancel reply Delete By Home PAGES Lectures View All RECOMMENDED FOR YOU Category ARCHIVE SEARCH ALL Lectures Not found any lecture match with your request, please help to write it and send it to our email at for making this website free accounting and finance encyclopedia. Back Home Sunday Monday Tuesday Wednesday Thursday Friday Saturday Sun Mon Tue Wed Thu Fri Sat January February March April May June July August September October November December Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec just now 1 minute ago $$1$$ minutes ago 1 hour ago $$1$$ hours ago Yesterday $$1$$ days ago $$1$$ weeks ago more than 5 weeks ago Followers Follow THIS CONTENT IS PREMIUM Please share to unlock