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Capital Budgeting

 Self-Paced Overview

Capital Budgeting Techniques

Internal Rate of Return

The internal rate of return (IRR) on a project is the rate of return where the cash inflows (net cash flows) equals the cash outflows (net investment.) The easiest way to find IRR is to use a financial calculator or spreadsheet program.

An example of a project with a net investment of $10,000, net cash flows of $5,000, $4,000, $3,000, $2,000, $1,000 for years 1 through 5 returns an IRR of 20.27%.

To determine this using Microsoft Excel 2007, enter the numbers in our example into Column A starting at Row 1 with the net investment shown as a negative number.

The column of data appears:

  A B
1 -10000  
2 5000  
3 4000  
4 3000  
5 2000  
6 1000 =IRR(A1:A6)
7    

Once you have entered the column of numbers as detailed, position the cursor in an adjacent, empty cell and insert the IRR function, which is: =IRR(). Within the function, you need to reference the cells that contain the numbers for which you want to calculate IRR; in this case, cells A1 through A6. So, the final function will look like: =IRR(A1:A6). Once you have this, press [ENTER] and the result of the function formula will be 20%.

Formatting a Number in Excel 2007

In our example above, we calculate the IRR to two decimal places. To do this in Excel, select the cell containing the IRR function formula and click the small arrow on the lower right of the Number group on the Home tab of the Ribbon. The Format Cells dialog box will appear. The Number tab should be selected with the Percentage category selected. On the right you will notice a box allowing you to change the decimal places. In this box, enter 2 and click OK. The IRR should now be 20.27%.

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