A Note On The Financial Evaluation Of Projects
 <<Previous
NET PRESENT VALUE Contd..
To develop a better understanding of the calculation of the IRR, take a look
at the following examples:
Firm XYZ Ltd. is planning to invest Rs 65,000 in its new project. This
project is expected to last for 5 years. Its estimated cash flows are Rs
12,500, Rs 15,300, Rs 16,700, Rs 13,400 and Rs 14,300 for the year one, two,
three, four and five respectively.
The IRR can be calculated using the following formula:
Using the trial and error method[7], different rates are substituted in the
formula to find out which value can equalize the two sides of the
formula. Let us first substitute “r” with 4%; then the left hand side of
the equation changes to:
By using 4%, the value derived after solving the equation is less than Rs 65000. Hence, we take 3%.
|
|
By using 3%, the value derived after solving the equation is more than Rs
65000. It is therefore clear that the actual IRR lies somewhere between 3%
and 4%. Using interpolation[8], we find out a single value of IRR. The actual
IRR calculated using interpolation is 3.67%. When the payback period is
given, the IRR can be calculated as follows:
Where PB = Payback period
DFr = Discount factor for interest rate r
DFrL = Discount factor for lower interest rate
DFrH = Discount factor for higher interest rate.
More...
APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS
CONCLUSION
EXHIBIT I ASPECTS OF PROJECT APPRAISAL
EXHIBIT II PROJECT EVALUATION TECHNIQUES
[7] Under this method we assume different discount rates to equal the right
hand side of the equation to obtain the actual internal rate of return ‘r.'
[8] It is a statistical technique of finding a fairly approximate estimate
of the unknown value of a function in absence of complete data.
2010, ICMR (IBS Center for Management Research).All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted
in any form or by any means - electronic or mechanical, without permission.
To order copies, call +91- 8417- 236667 or write to ICMR,
Survey No. 156/157, Dontanapalli Village, Shankerpalli Mandal,
Ranga Reddy District,
Hyderabad-501504.
Andhra Pradesh, INDIA.
Mob: +91- 9640901313, Ph: +91- 8417- 236667,
Fax: +91- 8417- 236668
E-mail: info@icmrindia.org
Website: www.icmrindia.org
|
More Classifications...