Irr and NPV

MATERIAL FORMULACIÓN Y EVALUACIÓN DE PROYECTOS (G2 Y G11)
INTERNAL RATE OF RETURN (IRR)
What Is Internal Rate of Return (IRR)?
The internal rate of return (IRR) is a metric used in financial analysis to estimate the
profitability of potential investments. IRR is a discount rate that makes the net
present value (NPV) of all cash flows equal to zero in a discounted cash flow
analysis.
IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is
not the actual dollar value of the project. It is the annual return that makes the NPV
equal to zero.
Generally speaking, the higher an internal rate of return, the more desirable an
investment is to undertake. IRR is uniform for investments of varying types and, as
such, can be used to rank multiple prospective investments or projects on a relatively
even basis. In general, when comparing investment options with other similar
characteristics, the investment with the highest IRR probably would be considered
the best.
KEY TAKEAWAYS
 he internal rate of return (IRR) is the annual rate of growth that an investment
is expected to generate.
 IRR is calculated using the same concept as net present value (NPV), except
it sets the NPV equal to zero.
 IRR is ideal for analyzing capital budgeting projects to understand and
compare potential rates of annual return over time.
Formula and Calculation for IRR

The formula and calculation used to determine this figure are as follows:
HOW TO CALCULATE IRR
1. Using the formula, one would set NPV equal to zero and solve for the discount
rate, which is the IRR.
2. The initial investment is always negative because it represents an outflow.
3. Each subsequent cash flow could be positive or negative, depending on the
estimates of what the project delivers or requires as a capital injection in the
future.
4. However, because of the nature of the formula, IRR cannot be easily
calculated analytically and instead must be calculated iteratively through trial
and error or by using software programmed to calculate IRR (e.g., using
Excel).
HOW TO CALCULATE IRR IN EXCEL
Using the IRR function in Excel makes calculating the IRR easy. Excel does all the
necessary work for you, arriving at the discount rate you are seeking to find. All you
need to do is combine your cash flows, including the initial outlay as well as
subsequent inflows, with the IRR function.
The IRR function can be found by clicking on the Formulas Insert (fx) icon.
Here is a simple example of an IRR analysis with cash flows that are known and
annually periodic (one year apart). Assume a company is assessing the profitability
of Project X. Project X requires $250,000 in funding and is expected to generate
$100,000 in after-tax cash flows the first year and grow by $50,000 for each of the
next four years.
In this case, the IRR is 56.72%, which is quite high.
IRR EXAMPLE
Assume a company is reviewing two projects. Management must decide whether to

move forward with one, both, or neither. Its cost of capital is 10%. The cash flow
patterns for each are as follows:
Project A
 Initial Outlay = $5,000

 Year one = $1,700
 Year two = $1,900
 Year three = $1,600
 Year four = $1,500
 Year five = $700
Project B
 Initial Outlay = $2,000

 Year one = $400
 Year two = $700
 Year three = $500
 Year four = $400
 Year five = $300
The company must calculate the IRR for each project. Initial outlay (period = 0) will
be negative. Solving for IRR is an iterative process using the following equation:
$0 = Σ CFt ÷ (1 + IRR)t
where:
 CF = net cash flow

 IRR = internal rate of return
 t = period (from 0 to last period)
-or-
$0 = (initial outlay * −1) + CF1 ÷ (1 + IRR)1 + CF2 ÷ (1 + IRR)2 + ... + CFX ÷ (1 +

IRR)X
Using the above examples, the company can calculate IRR for each project as:
IRR Project A:
$0 = (−$5,000) + $1,700 ÷ (1 + IRR)1 + $1,900 ÷ (1 + IRR)2 + $1,600 ÷ (1 + IRR)3

+ $1,500 ÷ (1 + IRR)4 + $700 ÷ (1 + IRR)5
IRR Project A = 16.61 %

IRR Project B:
$0 = (−$2,000) + $400 ÷ (1 + IRR)1 + $700 ÷ (1 + IRR)2 + $500 ÷ (1 + IRR)3 + $400

÷ (1 + IRR)4 + $300 ÷ (1 + IRR)5
IRR Project B = 5.23 %
“Given that the company’s cost of capital is 10%, management should proceed with
Project A and reject Project B.”
ANOTHER RESOURCES
VIDEOS EN ESPAÑOL
TASA INTERNA DE RETORNO (TIR)

https://www.youtube.com/watch?v=vWylceW23Ko
VALOR PRESENTE NETO (VPN)

https://www.youtube.com/watch?v=0xidh9r9RlY
TIR Y VPN EJERCICIO

https://www.youtube.com/watch?v=VNKgxyu5bPc
VIDEOS EN INGLÉS
INTERNAL RATE OF RETURN (IRR)

https://www.youtube.com/watch?v=NjJ3Qx3zrus
NET PRESENT VALUE (NPV)

https://www.youtube.com/watch?v=JBFRtxV6fFw

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MATERIAL FORMULACIÓN Y EVALUACIÓN DE PROYECTOS (G2 Y G11)

INTERNAL RATE OF RETURN (IRR)

What Is Internal Rate of Return (IRR)?

Formula and Calculation for IRR

HOW TO CALCULATE IRR

HOW TO CALCULATE IRR IN EXCEL

Assume a company is reviewing two projects. Management must decide whether to

 Initial Outlay = $5,000

 Initial Outlay = $2,000

 CF = net cash flow

$0 = (initial outlay * −1) + CF1 ÷ (1 + IRR)1 + CF2 ÷ (1 + IRR)2 + ... + CFX ÷ (1 +

$0 = (−$5,000) + $1,700 ÷ (1 + IRR)1 + $1,900 ÷ (1 + IRR)2 + $1,600 ÷ (1 + IRR)3

IRR Project A = 16.61 %

$0 = (−$2,000) + $400 ÷ (1 + IRR)1 + $700 ÷ (1 + IRR)2 + $500 ÷ (1 + IRR)3 + $400

IRR Project B = 5.23 %

TASA INTERNA DE RETORNO (TIR)

VALOR PRESENTE NETO (VPN)

TIR Y VPN EJERCICIO

INTERNAL RATE OF RETURN (IRR)

NET PRESENT VALUE (NPV)

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