Internal rate of Return Method

Internal Rate of Return or IRR can be defined as the interest or the returns one gets on an investment of money in any preposition ranging from stocks, banks accounts, and privately held companies. It is an annualized rate of return on investment and is compounded accordingly. An Internal Rate of Return is considered to be good if the return on investment in one portfolio is found to be better than the other. It is all about looking at the available options and choosing which is the best through a look at all factors and possible returns that can be yielded from each, along with cash flow considerations. The option which is most lucrative in terms of returns is then identified, allowing decisions to be made accordingly.

A preposition is good if the Internal Rate of Return of a particular option is better than the Internal Rate of Return of another option where the same investment over a period of time might not give as much return as in the case of short listed ones.

The Internal Rate of Return is considered good or profitable if it is more than the hurdle cost. Hurdle cost is the cost of capital. Though the Internal Rate of Return method is widely used and is a simplified method, its use can still be great for those who are inexperienced. It is vital that further calculations are done before making an investment decision.

An initial investment might be lower in one case than in another, but the NPV or the net present value in the second option might be a better option overall. Internal Rate of Return should be considered in calculating the feasibility and economic viability of a project. Two projects in different and mutually exclusive domains might not have the same platform or variables to arrive on a comparable conclusion, hence it is a method used in case by case scenarios.

The Internal Rate of Return is governed by the signs, mathematical signs (+,-), to denote the cashflow and if these are in positive or negative form. An Internal Rate of Return is generally the one starting with negative cash flow. An Internal Rate of Return does not necessarily denote the actual rate of return as it fails to take into account the intermediate cash flows which are not reinvested, hence giving a lower Internal Rate of Return in case of banks and stock options.

The Internal Rate of Return is calculated in percentages as compared to the net present value which is calculated in currency dominations. This aspect makes Internal Rate of Return a more popular method for evaluation of investment for the investors as compared to net present value though net present value is more accurate. Generally both methods are used in calculating the viability of the investment and if in a case, Internal Rate of Return is higher in one project and net present value is higher in the other then the cross over point method can be brought into consideration to solve the problem.