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Internal Rate of Return Method Of Capital Budgeting And Evaluation

Internal Rate of Return Method Of Capital Budgeting And Evaluation:

Internal rate of return is time adjusted technique and covers the disadvantages of the traditional techniques. In other words it is a rate at which discount cash flows to zero.

It is expected by the following ratio:

Internal Rate of Return = Cash inflow / Initial Investment

Steps to be followed:

Step1. Find out factor

Factor is calculated as follows:

F= Cash outlay (or) initial investment / Cash inflow

Step 2. Find out positive net present value

Step 3. Find out negative net present value

Step 4. Find out formula net present value

finance
[Post Image Courtesy of Stuart Miles at FreeDigitalPhotos.net]

Formula For Internal Rate of Return Method Of Capital Budgeting And Evaluation:

IRR = Base factor + (Positive net present value / Difference in positive and Negative net present value) x DP

Base factor = Positive discount rate

DP = Difference in percentage

Merits Of Internal Rate of Return Method Of Capital Budgeting And Evaluation:

1. It consider the time value of money.

2. It takes into account the total cash inflow and outflow.

3. It does not use the concept of the required rate of return.

4. It gives the approximate/nearest rate of return.

Demerits Of Internal Rate of Return Method Of Capital Budgeting And Evaluation:

1. It involves complicated computational method.

2. It produces multiple rates which may be confusing for taking decisions.

3. It is assume that all intermediate cash flows are reinvested at the internal rate of return.

Accept/Reject criteria For Internal Rate of Return Method Of Capital Budgeting And Evaluation:

If the present value of the sum total of the compounded reinvested cash flows is greater than the present value of the outflows, the proposed project is accepted. If not it would be rejected.

Excess Present Value Index

Excess present value is calculated on basis of net present value. It gives the results in percentage.

About Author Mohamed Abu 'l-Gharaniq

when an unknown printer took a galley of type and scrambled it to make a type specimen book. It has survived not only five centuries.

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