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Rate of Return Analysis
Objectives
• Evaluate cash flows by the
internal rate of
return
(IRR) method
• Plot present worth (PW) of a project
against interest rate
• Use an
incremental
rate of return analysis
to evaluate competing alternatives
Internal Rate of Return
• Internal Rate of Return is defined as the interest
paid on the unpaid balance of a
loan
such that
the payment schedule makes the unpaid loan
balance equal to zero when the final payment is
made.
• Internal Rate of Return is the interest earned on
the unrecovered
investment
such that the
payment schedule makes the unrecovered
investment equal to zero at the end of the life of
the investment.
•
The Internal Rate of Return is the interest
rate at which the benefits are equivalent to
the cost
, (or at which NPW=0)
.
Calculating Rate of Return
Convert consequences into cash flow and
solve this for unknown value of
internal
rate of return (IRR)
using one of:
• PW
benefits
– PW
costs
= 0
•
PW
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 Fall '11
 GG

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