The below mentioned article provides the formula of internal rate of return.
Internal rate of return (IRR) is a rate that equates cash flow of different points of time. IRR is the rate “r” for which –
Assume that a company raise Rs.100 million loans @10% p.a. repayable at the end of 5 years at a premium of 1%. Tax saving is at the rate of 30%. Thus net cash outflow for the loan is Rs.7 for the first through 4th year and Rs.108 at the end of fifth year.
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Let us now replace the symbols and use the figures:
To solve this equation, we may follow Trial and Error method.
Assume discount factor 8% and check whether the RHS becomes 100. We find it becomes 96.6879. This means to make the RHS 100 we need to reduce the discount factor to 7%.
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Assume 7% discount factor and check whether the RHS becomes 100. We find it becomes 100.7130.
So the given cash flow can be discounted to Rs.100 using a rate that falls between 7%- 8%. Applying linear interpolation, we may find out IRR.
Alternatively, We may use Excel function to calculate IRR. Place your Cursor at Cell A7: Command = IRR (A1:A6)
