Suppose a project's payback period is 3.52 years. Its initial investment is
Rs 75000 and its average annual cash flows are Rs 21300. Then discount
factors closer to 3.52 are 3.605 at 12% and 3.517 at 13%. From this we can
assume that the IRR is between 12% and 13%. We can calculate the actual IRR
with the help of the above formula.
•In case of mutually exclusive projects, the IRR method might accept a
project with higher IRR but with a relatively low NPV. This is because
the IRR assumes that all the cash inflows are again invested in the
project at the internal rate of return.
The evaluation criteria for the project using the IRR method are:
•The project is accepted when the IRR is greater than the cost of capital or
required rate of return.
•The project is rejected when the IRR is less than the cost of capital or
required rate of return.
•The project reaches the point of indifference when the IRR is equal to the
cost of capital or the required rate of return.
•When there are mutually exclusive projects, the one with the highest IRR
must be selected.
MULTIPLE RATES OF RETURN
Projects do not always have cash inflows every year. Sometimes, negative
cash flows or cash outflows occur, particularly when projects involve heavy
investments or have long gestation periods. This situation is the basic
reason for the realization of multiple rates of return.
Example:
Consider a project which has following cash flow streams and calculate
internal rate of return:
|
Year
|
Cash flow |
|
0
|
-1000 |
|
1
|
7000 |
|
2
|
-12000 |
More...
APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS
CONCLUSION
EXHIBIT I ASPECTS OF PROJECT APPRAISAL
EXHIBIT II PROJECT EVALUATION TECHNIQUES
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