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Return on Investment – Internal Rate of Return. By R. S. Miolla. Agenda. 1) What is return on investment (ROI)? 2) Internal Rate of Return 3) Net Present Value Method (NPV) compared to Internal Rate of Return (IRR). 1) ROI or Capital Budgeting.

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Return on Investment – Internal Rate of Return


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    1. Return on Investment – Internal Rate of Return By R. S. Miolla

    2. Agenda • 1) What is return on investment (ROI)? • 2) Internal Rate of Return • 3) Net Present Value Method (NPV) compared to Internal Rate of Return (IRR).

    3. 1) ROI or Capital Budgeting • Answers: Is this a good financial investment? • Simple ROI computed as (Returns – Investment)/Investment • Assume 10k investment, 3k return for 4 years • (12,000-10000)/10,000 = 20% • A long-term investment • Example: buying equipment, opening a plant • Simple ROI may use cash or profit as return.

    4. 2) Internal Rate of Return (IRR) • Gives the % rate of return on the investment. Computed based on the cash inflows and time value of money. • Can be called the yield on the investment. • Contrast to Simple Return on Investment = {(return-investment)/investment}/# years. • Note simple ROI can be annualized.

    5. 2) IRR - Calculation • Can be done in Excel • Financial calculator • Online calculator • Phone Apps • Financial tables

    6. 2) IRR - Example • Investment of $50,000 • Return or cash inflow of $20,000 a year for 3 years. • IRR = 9.7%

    7. Strengths of IRR vs. NPV • 1) Projects of different initial investments are easily compared. • 2) A firm can set a hurdle rate for IRR (maybe its cost of capital plus 5%) and all projects are easily compared to the hurdle rate.

    8. Summary • 1) Return on investment. • 2) Internal rate of return. • 3) NPV and IRR compared.