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IRR Study Notes

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4 views1 page

IRR Study Notes

Uploaded by

kent68058
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Internal Rate of Return (IRR) - Study Notes

Definition
Internal Rate of Return (IRR) is the discount rate that makes the Net Present Value
(NPV) of an investment equal to zero.

Formula
0 = -C0 + C1/(1+r) + C2/(1+r)^2 + ... + Cn/(1+r)^n

Exam interpolation formula:


IRR = Lower Rate + [NPV at Lower Rate / (NPV at Lower Rate - NPV at Higher Rate)] ×
(Higher Rate - Lower Rate)

Example
NPV at 10% = +500; NPV at 15% = -200.
IRR = 10 + (500/(500-(-200)))×5 = 13.57% (≈13.6%).

Advantages
• Easy to understand as a percentage.
• Helps compare investment projects.
• Considers the time value of money.
• Uses all project cash flows.

Disadvantages
• Can produce multiple IRRs with unusual cash flows.
• Assumes reinvestment at the IRR.
• May rank projects differently from NPV.
• Can be difficult to calculate manually.

Important Exam Notes


• Accept a project if IRR is greater than the required rate of return (cost of capital).
• Reject if IRR is lower than the required rate.
• IRR should be used together with NPV for better decisions.
• Higher IRR generally indicates a more profitable investment.

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