1. Internal Rate of Return
The internal rate of return or IRR is the discount rate that makes
the net present value of an investment equal to zero,
it is the expected compound annual rate of return that will be earned
on an investment. Once the IRR is determined, it is typically compared to
a company's cost of capital, sometimes known as the hurdle rate.
In general, if the IRR is greater than the cost of capital,
then the project should be profitable, if the IRR is less than the
cost of capital, do not invest in the project.
The IRR function in Excel returns the internal rate of return for a
series of cash flows that occur at regular intervals.
The IRR function syntax has the following components, one, the cash flow
values, these are a required element, the cash flows must contain at least
one negative value, usually the first cash flow
and at least one positive value. Furthermore, the values should be in chronological
order. The second argument in IRR is not required, the analyst can put
in a guess, an estimate, of what the IRR could be,
if this is omitted from the function, Excel assumes it to be 10%.
But again, it's not necessary to enter a guess.
Similar to the XNPV function, where the timing for cash flows can occur
at irregular intervals, the XIRR function can also accommodate non periodic
cash flows. The XIRR function has the following syntax.
The first one is values, again this is a required element,
the array of values must contain at least one positive value and one
negative value, and the value should be in chronological order
just like the regular IRR function. The second argument is dates,
this is also a required element and the dates should correspond to the
schedule of cash flows. The third and final argument is the guess, again
this is an optional element.
2. Let's practice!