Since we published Internal Rate of Return content in Accounting Education we've gotten a bunch of feedback, most of which was overwhelmingly positive. Today, we're happy to write even more simplified to Internal rate of return that we've implemented as a direct result of your feedback. We've also written "IRR wikipedia" to better reflect all of the IRR and its comparison with NPV provided by Wikipedia content. As requested by many of you, we've also written "MIRR" and Advantages and Disadvantages of IRR for clearing everything about IRR. Today we will provide you 5 tips which will make Internal rate of return simplified.
Tip No. 1 #
Remember Internal rate of return is nothing but high rate of return than normal rate of return.
Tip No. 2 #
There are three situation in which internal rate of return is calculated.
( First situation )
When we will earn equal profit on our investment.
( Second situation )
When we will not earn equal profit on our investment but after hit and trial, we will find the rate where our present value of profit will equal to the cost of investment.
( Third situation )
When we will not earn equal profit on our investment but after hit and trial, we will not find the rate where our present value of profit will equal to the cost of investment.
Tip No. 3 #
We can say simply that calculating of Internal rate of return is just playing the game of Hide and Seek in which actual internal rate is hidden and you have to seek it. Because, this method of capital budget gives us freedom to assume any rate as internal rate of return. We can assume simply 10%, 11%, 12%, 13% and more but in these assume or estimated rates, real value of IRR will be that which clear condition of following
Present value of cash inflow is following
Net profit of specific period on investment X present value factor which is calculated on the basis of estimated IRR
Present Value of cash outflow is following
Cost of investment X present value factor which is calculated on the basis of estimated IRR.
Tip No. 5 #
Under stand the formula of IRR
IRR =
lower rate + NPV at lower rate / cash inflows at lower rate - cash inflows at higher rate X ( higher rate - lower rate )
Meaning
Simple Example of IRR Problem and Solution
Tip No. 1 #
Remember Internal rate of return is nothing but high rate of return than normal rate of return.
Tip No. 2 #
There are three situation in which internal rate of return is calculated.
( First situation )
When we will earn equal profit on our investment.
( Second situation )
When we will not earn equal profit on our investment but after hit and trial, we will find the rate where our present value of profit will equal to the cost of investment.
( Third situation )
When we will not earn equal profit on our investment but after hit and trial, we will not find the rate where our present value of profit will equal to the cost of investment.
Tip No. 3 #
We can say simply that calculating of Internal rate of return is just playing the game of Hide and Seek in which actual internal rate is hidden and you have to seek it. Because, this method of capital budget gives us freedom to assume any rate as internal rate of return. We can assume simply 10%, 11%, 12%, 13% and more but in these assume or estimated rates, real value of IRR will be that which clear condition of following
Every estimated rate may be internal rate of return, if we calculate present value cash inflows and cash outflow with this rate and both will be equal with each other.Tip No. 4 #
Present value of cash inflow is following
Net profit of specific period on investment X present value factor which is calculated on the basis of estimated IRR
Present Value of cash outflow is following
Cost of investment X present value factor which is calculated on the basis of estimated IRR.
Tip No. 5 #
Under stand the formula of IRR
IRR =
lower rate + NPV at lower rate / cash inflows at lower rate - cash inflows at higher rate X ( higher rate - lower rate )
Meaning
Simple Example of IRR Problem and Solution
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