The internal rate of return is calculated to assess the performance of an investment. This indicator is determined by the internal properties of the project, without the use of external parameters. At the same time, he sets the upper bound for the profitability of the investment project and its maximum unit costs. Based on a comparison of the internal rate of return with a number of indicators, the investor makes a decision on how to invest his funds.
Instructions
Step 1
Set net present value (NPV) to zero. This condition is mandatory for calculating the indicator of the internal rate of return (IRR). The NPV indicator determines the amount of money that the investor seeks to receive from the project after the initial investment costs have been paid off. Since the internal rate of return determines the level of costs, there is no need to take into account the profit to be calculated.
Step 2
Determine the amount of the initial investment that you plan to invest in the project. This parameter is denoted in the economy by the letter IC or I. It is also necessary to calculate the estimated amounts of input cash flows (CF), i.e. the amount of investment income. As a rule, for calculations, the value of profit in the first four years of the existence of an investment project is used.
Step 3
Use the formula for calculating net present value to determine the internal rate of return, which should be set to zero. Then solve the resulting equation in which the IRR is unknown. As a rule, to calculate this value, special software is used, for example, MathСad, with which you can not only calculate the indicator, but also analyze other investment factors. Ideally, it is necessary to obtain a graph of the dependence of NPV on the level of the discount rate (E). The intersection of the function with the E axis will be the solution to the equation
Step 4
Analyze the resulting value of the internal rate of return. If this indicator is greater than or equal to the cost of capital, then the investment project is recognized as profitable and accepted. If less, then it is rejected, because it means that the project capacity is not enough to provide the necessary return and return of money.
