Internal Rate of Return Lecture # 06

Internal Rate of Return:

 IRR is defined as discounting rate (%) at which Net Present Value of Project becomes or equal to
zero.
 When you are evaluating an investment, a useful number to know is the internal rate of return.

 To evaluate investments and calculate an internal rate of return, we need the concept of
income stream.

Formula for IRR:

( R 2−R1 )∗ NPV 1
IRR=R 1+
N −NPV
2
PV 1

Numerical 01:
YEAR CASHFLOWS DISCOUNTING NPV1 DISCOUNTING NPV 2
RATE10 % (R1) RATE %20 (R2)
0 (5000) - - - -
1 2000 0.909 1818 0.833 1666
2 2000 0.826 1652 0.694 1388
3 2000 0.751 1502 0.578 1156
4 100 0.683 68.3 0.483 48.3
5 100 0.621 62.1 0.400 40
6 100 0.564 56.4 0.335 33.5
7 100 0.513 51.3 0.270 27.9
210.1 (640.3)

( R 2−R1 )∗ NPV 1
IRR=R 1+
NPV 1−NPV 2

( 20 %−10 % )∗210.1
10 %+
210.1−(−640.3 )

( 10 % ) ( 210.1 )
¿ 0.1+
210.1+ 640.3

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 21.01
¿ 0.1+
850.4

¿ 0.1+0.0247

¿ 0.1247∗100

IRR=12.47 %

YEAR CASHFLOWS DISCOUNTING NPV1

RATE 12% (R1)
0 (5000) - -
1 2000 0.892 1784
2 2000 0.8 1600
3 2000 0.71 1420
4 100 0.636 63.6
5 100 0.56 56
6 100 0.50 50
7 100 0.452 45.2
5018.8

( R 2−R1 )∗ NPV 1
IRR=R 1+
NPV 1−NPV 2

¿ 5000−5018.8

¿ 18.8

IRR at 12% = (18.8)

Numerical 2:
Years Cash Flows
0 (5000)
1 800
2 900
3 1200
4 1400
5 1600
6 1300
7 1100

Discount Rate = 10%, Up to 20%, 40% Calculate IRR =?

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