Internal Rate of Return (IRR)

Written by Pablo Leandro Capellari- s213666

Abstract

Internal rate of return (IRR) is a parameter used in the financial analysis of investments to determine the profitability of the investment, in other words, it estimates the rate of return that the evaluated investment could have. The term "internal" is due to the fact that for the calculation of the IRR, external factors that could affect the profitability of the project, such as inflation, are not considered. In mathematical terms, the IRR is defined as the discount rate that causes the sum of the cash flows of the project to be zero. In other words, if the NPV of a project is 0 at a certain rate, that rate is the IRR (Patrick and French, 2016). Tang and Tang (2003) have validated the IRR as an alternative to the net present value (NPV) as an indicator for project evaluation, considering that the IRR as from the point of view of the investor and the NPV from the point of view of the society.

Big Idea

The net present value (NPV) method is the most frequently used approach in the financial appraisal of a project. This section highlights the background & relevancy of this topic.

What is IRR?

This section explain the concept of IRR

Assumptions of IRR

This highlights the underlying assumptions in NPV

Formula

This section introduces the IRR formula & recommended steps in the calculation of the IRR.

Applications

Application of NPV in real example

Limitations

Introduce the limitations of IRR

Alternative financial appraisal methods

This section gives a brief idea about other methods

• NPV
• payback
• ROI

Annotated Bibliography

Reference Example: The book-1. The book-2. The book-3. The book-4. The book-5.