The discount rate at the time of recoupment of the project is the internal rate of return. That is, the inflow and outflow of funds must match, and the net present value must be close to the rate of return. The internal rate of return determines the most acceptable discount rate when it is possible to make investments without losses for the owner.
Instructions
Step 1
Internal rate of return is a measure of investment performance. This term refers to the discount rate at which the project's present net worth is zero. In practice, the internal rate of return is compared with the discount rate, while if the rate of return is greater than or equal to the discount, the project provides a positive value, the percentage of income, which is equal to the difference between the rate of return and the discount.
Step 2
The rate of return is calculated based on the following indicators: a positive value and a discount. To do this, it is necessary to calculate a positive value at different levels of the discount rate until the value when the first becomes negative. And only then can the value of the internal rate of return be found by dividing the positive value by the difference between it and the negative value.
Step 3
If there are several alternative projects with the same values of the rate of return and a positive value, then when choosing the final investment option, duration is taken into account, which is the weighted average period of the project life cycle or the effective duration of the project. This value allows various projects to be brought to the same standard, differing in terms, methods of calculating interest and the number of periodic payments. The method is based on calculating the moment when the project begins to generate income and on the number of monthly or quarterly income receipts during its life.
Step 4
The effectiveness of the project in terms of the rate of return clearly shows the compliance of the rate of return with the established rate of return, which depends on the weighted average cost of capital. However, this rate is not always an objective indicator, since it shows the maximum amount of capital used to maintain a non-negative net worth. In the conditions of changing in different periods of positive and negative cash flows, the calculation of the rate of return leads to the fact that the investment project has several different rates of internal rate of return. In this case, the rate of return is meaningless.
