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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

S26-2 Using payback to make capital investment decisions

Carter Company is considering three investment opportunities with the following payback periods:

Project A

Project B

Project C

Payback period

2.7 years

6.4 years

3.8 years

Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.

P26-40 Using payback, ARR, NPV, and IRR to make capital investment decisions

This problem continues the Piedmont Computer Company situation from Chapter 25. Piedmont Computer Company is considering purchasing two different types of servers. Server A will generate net cash inflows of \(25,000 per year and have a zero residual value. Server A鈥檚 estimated useful life is three years, and it costs \)45,000. Server B will generate net cash inflows of \(25,000 in year 1, \)15,000 in year 2, and \(5,000 in year 3. Server B has a \)5,000 residual value and an estimated useful life of three years. Server B also costs $45,000. Piedmont Computer Company鈥檚 required rate of return is 14%.

Requirements

1. Calculate payback, accounting rate of return, net present value, and internal rate of return for both server investments. Use Microsoft Excel to calculate NPV and IRR.

2. Assuming capital rationing applies, which server should Piedmont Computer Company invest in?

Why are net present value and internal rate of return considered discounted cash flow methods?

Explain the difference between capital assets, capital investments, and capital budgeting.

How is payback calculated with equal net cash inflows?
See all solutions

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