Calculation Formula and method of Internal rate of return
Internal rate of return (Internal Rate of Return, referred to as IRR) is an important index to evaluate the benefit of investment projects, which can reflect the real profit level of investment projects. This paper will introduce the calculation method and formula of internal rate of return in detail to help investors understand and use this index better.
I. the concept of internal rate of return
The internal rate of return is the discount rate that makes the net present value (NPV) of the investment project equal to zero, that is, under this discount rate, the income of the investment project is equal to the cost. Investment projects are generally considered attractive when the internal rate of return is higher than the minimum rate of return required by investors.
Second, the calculation method of internal rate of return
The calculation of internal rate of return involves solving a polynomial equation, which is solved by iterative method or Newton method. Here, we focus on the calculation process of the iterative method.
First of all, we needDmarketnftblockchainUnderstand the calculation formula of net present value (NPV)Dmarketnftblockchain:
NPV = ∑ (CFt / (1 + r) ^ t)-I
Where: CFt represents the cash flow of the t period; r represents the discount rate; t represents the time; and I represents the initial investment.
The internal rate of return is actually solving an equation about r so that NPV = 0. The specific steps are as follows:
Determine the cash flow (CFt) and initial investment (I) of the investment project. Set an initial discount rate (R0), such as the minimum rate of return required by investors. The NPV value is calculated according to the set discount rate. If the NPV approaches zero, it is close to the internal rate of return; otherwise, adjust the discount rate (R0) according to the positive and negative values of NPV to bring it closer to zero. Repeat steps 3 and 4 until you find the discount rate that makes NPV close to zero, which is the internal rate of return.Third, the application scenario of internal rate of return
Internal rate of return (IRR) is widely used in investment project evaluation, enterprise value evaluation, financial product design and other fields. For investors, the internal rate of return is an important reference index, which is helpful to evaluate the profitability and investment risk of the project.
IV. matters needing attention
When calculating and applying the internal rate of return, you should pay attention to the following:
For projects with non-traditional cash flows (such as the alternation of multiple positive and negative cash flows), there may be multiple internal rates of return, which need to be compared and analyzed. The internal rate of return assumes that the cash flow generated by the project can be reinvested according to the internal rate of return, which may not be consistent with the actual situation. When comparing two similar term investment projects, the internal rate of return has a better reference value; but for the projects with large differences in duration, the modified investment payback period (MIRR) may be a more reasonable indicator.Through the introduction of this article, I believe that readers have a clear understanding of the calculation method and formula of internal rate of return. In the actual investment decision, investors can flexibly use the internal rate of return according to the specific situation to better evaluate the profitability and risk of the project.
