Internal Rate of Return (IRR)

(in Thousand of $)

Input
Periods 0 1
Cash Flow -800 400

2 Profit
X
3 Cost of the Proj

In our example, the total profit over three years is $(40

2 100
X
3 800
An approximate IRR is therefore calculated as:

A starting point is to try 8%

( a ) Try 8%

Periods 0 1
Cash Flow $ -800 400
Discount Factor (% ) 1.00 0.926
Formula (% ) 1.00 (1/1.08 )
Formula $ (-800X1.00 ) (400X.926 )
Present Value $ (800.00) 370.40

The NPV is negative, therefore the project fails to earn 8% and

( a ) Try 6%

Periods 0 1
Cash Flow $ -800 400
Discount Factor (% ) 1.00 0.943
Formula (% ) 1.00 (1/1.06 )
Formula $ (-800X1.00 ) (400X.943 )
Present Value $ (800.00) 377.20

The NPV is positive, therefore the project earns more than 6%

Calculation of IRR (Internal Rate of Return)

Formula
Internal Rate of Return (IRR)
=a%+{(A/A-B)X(b-a)}%
=6%+{12.2/(12.2+13.7)x(8-6)}%
=6%+0.942%
=6.942% (Approx)

Where
a a is one interest rate
b b is the other interest rate
A A is the NPV at rate a
B B is the NPV at rate b
 2 3
300 200

Profit
Cost of the Project

three years is $(400+300+200-800)=$100

100
800
ted as:

2 3
300 200
0.857 0.794
(1/(1.08*1.08)
(1/(1.08*1.08*1.08)
) )
(300X.857 ) (200X.794 )
257.10 158.80 ### (NPV )

ct fails to earn 8% and the IRR must be less than 8%

2 3
300 200
 0.890 0.840
(1/(1.06*1.06)
(1/(1.06*1.06*1.06)
) )
(300X.890 ) (200X.840 )
267.00 168.00 12.20 (NPV )

ct earns more than 6% and less than 8%

2+13.7)x(8-6)}%

=Lower Interest Rate

=High Interest Rate
=Positive NPV
=Negative NPV