A basic question on IRR
Hi,
So I understand that IRR is the interest rate at which the net present value of the cash flows are equal to zero.
Even though I understood this statement I still feel like I don't know what IRR is.
For example, if I were to say my ROCE is 50%, I can clearly put it in context saying for every 10 dollars I invested in the business I generated 5 dollars.
In a similar line of thinking, I still can't conclude what a 50% IRR would mean...? Can someone please help?
To put it (over)simply, think of it as the CAGR of an investment
So if I'm to say my IRR is 10%,
can I interpret it as my return on an investment over "n" years, in Project X, is a yearly 10%?
I still feel hollow about this... =\
Basically, yes - what don't you get about that?
replied below
To add some color to mrb's comment, CAGR is calculated as:
[(Ending Investment Value / Beg. Inestment Value)^(1/(n-1)]-1,
where n = total # of years from time 0 when u made the investment and time t when u sold it.
1) you are comparing IRR to bank interest because you want to make sure you are actually generating a return above your funding cost. Put differently if you were borrowing from a bank at 10% for a project that returns 8%, you wouldn't invest in the project
2) as with above, compare IRR to your cost of capital. Or just think of it as cagr. Not super relevant
3) it's really a balance of absolute $ value and IRR. Just think of a situation with a high IRR but low NPV because the investment is very short term, or something lower IRR but very high NPV over a really long term. Neither is ideal. But generally, as they say, "you can't eat IRR"
Your username is ironic?
3) From your answer i think you are saying IRR alone should be considered for assessing an investment's attractiveness...? That's well understood too.
My username serves as a motivational tool so I don't feel depressed when I'm taking way too much time to grab hold of a concept =]
Open up an Accounting & Finance undergraduate textbook or something similar. They normally give a very nice and clear explanation about the pros and cons of using IRR (as a %) vs. NPV (value) and why NPV above zero is the go-to hurdle.
I'm being serious about the A&F textbook.
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