Internal Rate of Return
Sometimes for two or more comparable projects, we find NPV=0 or NPVI=1. In such situation, we are supposed to use the criterion of Internal Rate of Return (IRR). There are two ways we may compute the IRR.
(i) With the use of diagram
(ii) With the use of tables
Before we explain these methods, we should know what IRR is. The IRR is the rate of return on investment at which the NPV=0 or NPVI=1. It is that r, which when applied to the aggregated discounted present values of return over the life of the investment project just covers the investment cost I (either one time Expenditure or spread over a number of years such that
The different between IRR and other concepts like Accounting ROI and NPV may be noted
(i) IRR does but A/c ROI does not take care of time value of money.
(ii) IRR=f (I, A, I and/or j, NPV=0 as the constraint) whereas NPV= f (I, A, and/or j,r,)
While calculating NPV or NPVI, r is know, whereas for IRR, r is unknown to start with.
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