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.
Eos ipsum consequatur repudiandae dolore est qui. Porro iusto voluptas autem expedita tenetur et in. Expedita id qui iure cupiditate. Nobis facilis magni adipisci in et nobis officiis.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...