Internal rate of return IRR
In case of IRR method cash flow are analyzed taking into account the magnitude and the timing. IRR is that discount rate which gives a net present value equal to zero. The IRR method will also give the same decision as the NPV method in case of non-mutually exclusive projects. In case of independent projects one with highest IRR will be accepted (Robert Parrino & David s. Kidwell, 2009).
Where r= Internal Rate of Return
K=opportunity cost of capital.
Merits of IRR:
• Like NPV method, IRR methods also consider time value of money.
• All cash flow are taken to calculate rate of return
• Shareholders wealth maximinsation objectives given importance.
Demerits of IRR:
• Given misleading and inconsistent result when the NPV does not decline with the discount rate.
• Difficulty in making decision when mutually exclusive project exists
• IRR method fails to give an actual exists annual profitability of an investment.
• IRR method makes in realistic assumption that interim positive cash flow are reinvested at the same rate of return.
• More than one IRR exists for projects with alternative cash flow this leads to confusion and ambiguity (I.M. Pandey, 2005).