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# USING the IRR & NPV functions

## [referred to in the text in Problems 14.9, 14.11, and 14.12]

To see the formula used for each calculation, click on a cell in the relevant column

These functions evaluate streams of income from two different points of view: internal rate of return (IRR) and net present val
functions assume that payments follow fixed patterns. Here payments can follow any pattern.

Example #1
The IRR( ) function
Consider the following data that may for example be the income flow from a bond with \$100 face value, purchased at par, pay
The function is filled in as "=IRR(values)" where values can be a range (e.g., B17:B27) or a list (e.g, B15, B18, B19, . . ., B2
Year
0
1
2
3
4
5
6
7
8
9
10
IRR

Income Stream
-100 Note 1 payments are shown as negative numbers; receipts as positive nu
2
2 Note: the string of 2 is the annual coupon = 2% of face value
2
2
2
2
2
2
2 The last receipt is the last coupon (\$2) + the face value (\$100)
102

2.00% Note: the internal rate of return of a bond selling at par should be exactly

## The NPV( ) function

Using the same data as above. NPV also requires that an interest rate be specified. Here we specify 2% (=0.02)
The function is filled in as "=NPV(rate, values)" where rate is the interest or discount rate expressed in natural units (i.e., 2%
NPV

\$0.00 Note: the NPV is zero for a bond selling at par; the present value of the p

Note: interest rates must be expressed in the units appropriate to the periodicity of the data. Here they are expressed at an a
by IRR( ) must be multiplied by 4 to get the annual rate and an annual rate used as an input to NPV( ) must be divided by 4.

Example #2
The IRR( ) function
Consider the following data that may for example be the income flow from a bond with \$100 face value, purchased at a discou

Year

Income Stream
0
1
2
3

-98 Note 1: here the bond is purchased at a discount (i.e., below its face valu
2
2
2

4
5
6
7
8
9
10

IRR

2
2
2
2
2
2
102

2.23% Note: the internal rate of return of a bond selling at a discount should be

## The NPV( ) function

Using the same data as above we can evaluate NPV any specified interest rate. NPV = 0 if we use 2.23% (the internal rate of

NPV at 2.23%
NPV at 2.00%

(\$0.00)
\$1.96

Example #3
Variable Income Streams
In the examples above, we evaluated the fixed income streams of bonds, but IRR( ) and NPV( ) can be used to evaluate any

Year
0
1
2
3
4
5

IRR
NPV at 8.01%
NPV at 2.00%

Income Stream
-1000 Note 1: here the bond is purchased at a discount (i.e., below its face valu
-175
500
860
125
-60

8.01%
(\$0.00) Note: the net present value of an income stream discounted at its interna
\$177.01

nd 14.12]

## ck on a cell in the relevant column

wo different points of view: internal rate of return (IRR) and net present value (NPV). They are similar to the RATE and PV functions, excep
ns. Here payments can follow any pattern.

e the income flow from a bond with \$100 face value, purchased at par, paying a 2% annual coupon.
alues can be a range (e.g., B17:B27) or a list (e.g, B15, B18, B19, . . ., B27):

Note 1 payments are shown as negative numbers; receipts as positive numbers. Note 2: here the bond is purchased at par (i.e., at its fac
Note: the string of 2 is the annual coupon = 2% of face value

The last receipt is the last coupon (\$2) + the face value (\$100)

Note: the internal rate of return of a bond selling at par should be exactly its coupon rate as here.

## hat an interest rate be specified. Here we specify 2% (=0.02)

here rate is the interest or discount rate expressed in natural units (i.e., 2%=0.02) and values can be a range or a list as above:
Note: the NPV is zero for a bond selling at par; the present value of the positive income exactly equals the purchase price.

appropriate to the periodicity of the data. Here they are expressed at an annual rate. For quarterly data the rate generated
l rate and an annual rate used as an input to NPV( ) must be divided by 4. For monthly data the factor/divisor is 12 and so forth.

e the income flow from a bond with \$100 face value, purchased at a discount from face value (say, \$98), paying a 2% annual coupon.

Note 1: here the bond is purchased at a discount (i.e., below its face value).

Note: the internal rate of return of a bond selling at a discount should be above its coupon rate as here.

V any specified interest rate. NPV = 0 if we use 2.23% (the internal rate of return) but is positive if we stick to 2% (=0.02)

me streams of bonds, but IRR( ) and NPV( ) can be used to evaluate any income stream. For example:

Note 1: here the bond is purchased at a discount (i.e., below its face value).

Note: the net present value of an income stream discounted at its internal rate of return is zero.

## a the rate generated

divisor is 12 and so forth.

## paying a 2% annual coupon.

ick to 2% (=0.02)