In order to build shareholder equity, firms carefully evaluate projects to decide which projects they should fund and which they shouldn’t.
The project management team of a company seeks projects that can enhance shareholder’s value and avoid those that cannot earn back the cost of the capital.
When it comes to evaluating projects, the IRR or internal rate of return is considered to be one of the most widely used methods. IRR is used to calculate the projects return rate or the desirability of an investment. It is a popular metric in capital budgeting to measure the profitability of a project.
The higher the IRR of a project, the more desirable it will be. Consider this; all projects that you are evaluating require more or less the same up-front investment. In such a scenario, it’s best to calculate the internal rate of returns to narrow down your choice and undertake the best one with the highest IRR.
The internal rate of return is also described as an important indicator of:
- The efficiency
- Quality
- And also the yield of a project investment
It is a rate of interest that makes NPV (the net present value) zero. IRR is a discounted cash flow technique that offers project investors a good way to judge an investment and make an informed decision.
How is IRR Calculated?
Since the IRR makes NPV zero the calculations of IRR, incorporate the same computation formula as NPV.
Further Reading
- The internal rate of return (IRR) as a financial indicator – www.tandfonline.com [PDF]
- A resolution to the NPV–IRR debate? – www.sciencedirect.com [PDF]
- A different perspective on using multiple internal rates of return: the IRR parity technique – www.tandfonline.com [PDF]
- Prepurchase financing pool: Revealing the – www.tandfonline.com [PDF]
- The Limited Relevance of the Multiple – www.tandfonline.com [PDF]
- Environmental project evaluation: IRR-based decision support with a Monte Carlo simulation algorithm – www.tandfonline.com [PDF]
- The hazards of using IRR to measure performance: The case of private equity – papers.ssrn.com [PDF]
- Re-examining an old question: Does the IRR method implicitly assume a reinvestment rate? – www.jstor.org [PDF]
- The variable financial indicator IRR and the constant economic indicator NPV – www.tandfonline.com [PDF]
- Interest Rate Liberalization and Credit Rationing; A Real Option Model Based on IRR [J] – en.cnki.com.cn [PDF]
