RicherFin Education

Corporate Finance

IRR and Investment Criteria

The internal rate of return expresses a project's cash-flow pattern as an implicit return. The course explains its calculation, interpretation and the circumstances in which IRR no longer ranks investments reliably.

Course purpose

The decision examined

A percentage return is intuitive, but it can conceal project scale, cash-flow timing and multiple mathematical solutions. Mutually exclusive investments must therefore be ranked by the value they create at the required return.

Objectives

Learning outcomes

  • Define IRR as a root of the NPV function.
  • Separate project acceptance from project ranking.
  • Identify non-conventional cash flows and conflicting criteria.

Concepts

Key concepts

  • IRR
  • NPV profile
  • Crossover rate
  • Equivalent annuity
  • Capital rationing

Syllabus

Course structure

  1. IRR definition
  2. Acceptance rule
  3. Conflicting rankings
  4. Non-conventional cash flows
  5. Different lives
  6. Capital constraints

Extract

Analytical framework

The rate that sets NPV to zero

IRR is the rate i at which the present value of inflows exactly offsets the outflows:

Internal rate of return

0 = ∑t=0nCFt(1+i)t

For a conventional cash-flow pattern, the project is acceptable when IRR exceeds the required return. The rule does not state how much monetary value the project creates.

Full course

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