Comprehensive Analysis of Internal Rate of Return and Investment

This project analyzes the Internal Rate of Return (IRR) method, its calculation, and its application in investment decision-making. The solution demonstrates the process of calculating IRR using interpolation, comparing it to the direct cap method. It highlights the significance of IRR in achieving a zero Net Present Value (NPV) and its role in market expectations. The assignment further explains the relationship between the discount rate and IRR, emphasizing that the discount rate is determined through interpolation. The project includes example calculations using different discount rates, providing a clear understanding of how IRR is determined and used in financial analysis. The assignment is designed to help students understand the practical application of IRR in financial decision-making.

Answer 1
IRR is that value of percentage at which the Present value of Cash outflows match with Present value
of Cash inflow
In the above question, let us assume initial investment $1359036 and year wise cash inflow as under
Year 1 111994
Year 2 112931
Year 3 113873
Year 4 and onwards 114821
Growth rate
8% 0.900900901
0.811622433
Assume Discounted rate
@ 11.00%
Year Cash inflow PV Factor
PV Cash
inflow Cash outflow
0 0 1 0 -1359036
1 111994 0.9009 100895
2 112931 0.8116 91657
3 1549136 0.7312 1132715
1325268 -1359036
NPV -33768
Assume Discounted rate
@ 9.00%
Year Cash inflow PV Factor
PV Cash
inflow Cash outflow
0 0 1 0 -1359036
1 111994 0.9174 102747
2 112931 0.8417 95052
3 1549136 0.7722 1196217
1394016 -1359036
NPV 34980
By Interpolation
Highest 11 -33768
Lowest 9 34980
Decrease 2 -68748
Decrease required for 0
NPV 0.98 -33768
(-33768 x 2) / -68748
IRR 10.02

Answer 2
It is obvious that there is going to be a difference between our calculation of IRR and Direct Cap
methods.
In IRR Method we can find out exact value of the investment required to get a Nil Net present value.
In direct Cap method, the exact figures cant be derived.
IRR is calculated by interpolation and hence gives the most accurate answer
Answer 3
IRR method used is the best method amongst all. The net present value calculated at IRR method is
always nil. Hence the IRR method is used for decision making. It also decides the expectations in the
market
Answer 4
Discount rate is always equal to IRR because it is the rate which is calculated by interpolation. A
Random value of Discounting factor is selected which gives a negative Net present value. Then
another random figure is assumed which gives a positive Net present value. The difference between
the two percentage assumptions, is the actual IRR. The method followed is Interpolation. And hence
the Discounted rate is always equal to the IRR