Internal rate of return (IRR)

Internal rate of return (IRR) is the interest rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected net annual cash flows.

The internal rate return method differs from the net present value method in that it finds the interest yield of the potential investment.

The determination of the internal rate of return involves two steps.

Step 1. Compute the internal rate return factor. The formula for this factor is:

Capital Investment / Net Annual Cash Flows = Internal Rate of Return Factor

Step 2. Use the factor and the present value of an annuity of 1 table to find the internal rate of return.

Definition 2.

Internal rate of return (IRR) is a capital budgeting approach in which the discount rate is found that matches the present value of expected future cash inflows with the present value of outflows.


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