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Chapter 26: Q25RQ (page 1464)

What is the internal rate of return?

Short Answer

Expert verified

The internal rate of return (IRR) is a statistical tool used for various financial research. It is used to define the profitability of potential investments. A discount rate brings all future cash flows net present values (NPV) to zero.

Step by step solution

01

Uses of IRR

The anticipated growth rate of project investment is represented by the internal rate of return (IRR) of a project. It can be compared to the rate of return attained through the stock market or other project investments.

02

Calculation of IRR

It is calculated by the difference between the initial investment value and the net present value of future cash flows, dividing by the original amount and multiplying by 100.

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Most popular questions from this chapter

Hicks Company is considering an investment opportunity with the following expected net cash inflows: Year 1, 235,000;Year2,195,000; Year 3, 125,000.Thecompanyusesadiscountrateof6365,000. Calculate the NPV of the investment. Should the company invest in the project? Why or why not?

Refer to Short Exercise S26-4. Continue to assume that the expansion has no residual value. What is the project’s IRR? Is the investment attractive? Why or why not?

Water City is considering purchasing a water park in Omaha, Nebraska, for 1,920,000.Thenewfacilitywillgenerateannualnetcashinflowsof472,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation, and its stockholders demand an annual return of 12% on investments of this nature.

Requirements

1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index of this investment.

2. Recommend whether the company should invest in this project.

Using accounting rate of return to make capital investment decisions

Carter Company is considering three investment opportunities with the following accounting rates of return:

Project X

Project Y

Project Z

ARR

13.25%

6.58%

10.47%

Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company’s required rate of return is 8%.

Describe the capital budgeting process.
See all solutions

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