Internal Rate of Return

A sophisticated capital budgeting technique; the discount rate that equates the NPV
of an investment opportunity with Php0 (because the present value of cash inflows
equals the initial investment); it is the compound annual rate of return that the firm
will earn if it invests in the project and receives the given cash inflows.
Calculating the IRR
n

P 0=
t =1

C Ft
(1+ IRR)t
n

C F 0=
t=1

C F0

C Ft
(1+ IRR)t

Manual calculation of IRR using the formula above is not easy, since it involves trialand error techniques. Many financial calculators have IRR function that simplifies
the IRR calculation.

The Decision Criteria

When IRR is used to make acceptreject decisions, the decision criteria are as
follows:
If the IRR is greater than the cost of capital, accept the project.
If the IRR is less than the cost of capital, reject the project.
These criteria guarantee that the firm earns at least its required return. Such an
outcome should enhance the market value of the firm and therefore the wealth of
its owners.