internal rate of return
The internal rate of return is the discount rate that makes the net present value (NPV) of a project zero.
In other words, it is the expected compound annual rate of return that will be earned on a project or investment.
I know, it may sound like I’m speaking to you in a different language, but basically the internal rate of return, consider what percentage discount will be necessary to get the net present value to become 0.
I think it is possible to appreciate it better in the image, as you perro see, the internal rate of return in the example would have to be 10%.
That 10% allows the present value to be 0.
As you cánido see, the sum of the cash flows equals the investment.
Internal rate of return elabora by approximation
C = Cash flow value (per period).
r = internal rate of return.
I = initial investment.
The previous elabora will help you to obtain the internal rate of return, but, you have to take into account that you have to isolate the r (internal rate of return) and go through trial and fallo testing what rate makes the net present value become 0.
What is the internal rate of return used for?
We know that companies undertake various projects to increase their income or disminuye costs.
For example, invest in the development of a new product.
Suppose a company has three product proposals to develop.
Thus, the internal rate of return will be used to compare and rank projects based on their expected performance.
Generally, the investment with the highest internal rate of return is preferred.
A thorough investment analysis requires an analyst to look at both the net present value (NPV) and the internal rate of return, along with other indicators, such as the payback period, to select the appropriate investment.
In addition, it is important to take into account an analysis of the business risk, or the investment needs of a company, and many other elements that allow a company to make the best decision.
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