Unformatted text preview: r reject the project? Internal Rate of Return (IRR)
Internal Rate of Return (IRR) IRR is the discount rate that forces PV of inflows equal to cost, and the NPV = 0: CF
0 = ∑
t = 0 ( 1 + IRR )
n Solving for IRR with a financial calculator: Enter CFs in CFLO register.
Press IRR; IRRL = 18.13% and IRRS = 23.56%. Internal Rate of Return
Internal Rate of Return This is the most important alternative to NPV
It is often used in practice and is intuitively appealing
It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere Rationale for the IRR method
Rationale for the IRR method Definition: IRR is the return that makes the NPV = 0
If IRR > k, the project’s rate of return is greater than its costs. There is some return left over to boost stockholders’ returns. IRR Acceptance Criteria
IRR Acceptance Criteria If projects are independent, accept both projects, as both IRR > k = 10%.
If projects are mutually exclusive, accept S, because IRRs > IRRL. Reinvestment rate assumptions
Reinvestment rate assumptions NPV method assumes CFs are reinvested at k, the opportunity cost of capital. IRR method assumes CFs are reinvested at IRR. Assuming CFs are reinvested at the opportunity cost of capital is more realistic, so NPV method is the best. NPV method should be used to choose between mutually e...
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This document was uploaded on 01/14/2014.
- Winter '14