Internal Rate of Return Calculation Examples, Illustrations, Concept, Sample Help Online

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Meaning of Internal Rate of Return

Internal rate of return is that discounted rate which is used by the management to identify which capital investments or future project will yield an acceptable return and whether it is worth pursuing. Internal rate of return is the rate that equates the net present value of future cash flows from the project to zero. In simple language, it means if we have computed the present value of future cash flows from a project using the internal rate as the discount rate and subtracted out the original investment, our net present value of the project would be zero. This can be written as a formula in the following manner

(cashflow for year1/ (1+ IRR)1 + cashflow for year2/ (1+ IRR)2 + cashflow for year3/(1+IRR)3) – initial investment = 0

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Internal Rate of Return Calculation Examples Explanation

Let’s understand with help of an example

Example: Assuming that a company own’s a machine worth$100000. It will earn revenue as $20000, $30000, $40000 and $40000 so on… assuming 8% as the discounted rate.
($20000/(1+8%)1 + $30000/(1+8%)2 + $40000/(1+8%)3 + $40000/(1+8%)4 ) – $100000= $5393
As we can see that NPV is not equal to zero we have to assume 10 % as the discounted rate for which net present value of the costs of an investment equals the net present value of the expected future revenues of the investment.

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