Pharaoof
Accounts Personnel

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Please can any one explain me the way IRR is calculated???
I am working as an HR in one of the MNC NBFCs. Im unable to understand the way IRR is calculated.
I was told that IRR is diferent from the rate of interest we mention to the customers
Thanks in advance
Kranthi Kiran

From India , Mumbai
Hi Kranthi,

INTERNAL RATE OF RETURN: The internal rate of return (also called the time-adjusted rate of return) is a close cousin to NPV (Net Present Value). Both these methods are used in Capital Budgeting decision making. But, rather than working with a predetermined cost of capital, this method calculates the actual discount rate that equates the present value of a project's cash inflows with the present value of the cash outflows. In other words, it is the interest rate that would cause the net present value to be zero. IRR is a ranking tool. The IRR would be calculated for each investment opportunity. The decision rule is to accept the projects with the highest internal rates of return, so long as those rates are at least equal to the firm's cost of capital. This contrasts with NPV, which has a general decision rule of accepting projects with a "positive NPV," subject to availability of capital. Fundamentally, the mathematical basis of IRR is not much different than NPV.

The manual calculation of IRR using present value tables is a true pain. One would repeatedly try rates until they zeroed in on the rate that caused the present value of cash inflows to equal the present value of cash outflows. If the available tables are not sufficiently detailed, some interpolation would be needed. However, spreadsheet routines are much easier.

Hope this will clear ur doubts. Contact me for the excel calculation file, in case, if u require.

Cheers!

Raoof




From United Arab Emirates , Dubai
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