Internal rate of return (irr), Financial Management

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Internal Rate of Return (IRR) :

This rate attempts to find the earnings rate, which equates the current value of the streams of earnings to the investment outlay. IRR is described as the rate of return, which discounts all the future cash inflows to exactly equal the outlay.

Accept-Reject Rule:

The project with IRR higher than the cutoff rate will be accepted.  if not, it will be rejected.  The management will be indifferent if the IRR = cut-off rate.

Advantages:

  • It is useful and has several positive points
  • It assists the management in selecting the most profitable project
  • It understands the time value of money

Disadvantages:

  • It is difficult to calculate by trial and error method.
  • under definite conditions it becomes so difficult to take any decisions such as under conditions of unbalanced cash flows, IRR may give 2 or more answers.
  • It does not offer weight age of the volume of funds committed in the project.
  • It imagines that the funds received at the end of each year can be invested at the similar rate of return.

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