Internal rate of return on investment is popularly employed in commercial real estate but it's usually not understood by most traders due to the fact that it looks complicated from the outside. Then what is IRR you might ask, how is it being employed and what are the cons of the internal rate of return on investment, how does it work will all be clarified and resolved. IRR is the rate gained per dollar invested at a particular point in time, expressed in percentage (%).This quite helps the trader to differentiate between substitute investments based on their gains. IRR doesn't equate the compound rate of return on investment annually.

HOW TO CALCULATE THE INTERNAL RATE OF RETURN ON INVESTMENT

To calculate the IRR might seem like rocket science to newbie traders/ entrepreneurs. IRR calculation is not as hard as it seems especially when the rate of investment percentage is to be calculated for, the following is one of the most popular method of calculating the IRR;

Calculating for the intern rate of return on investment (IRR)

0=£^n/i-0 CF,/(1+IRR)'

There's more controversial definition of the IRR as the rate of discount that makes the net present value (NPV) equal to zero. The IRR tends to calculate the return of the outstanding investment gain remaining in an investment for each period of time it's invested. The outstanding investment under most circumstances tends to increase/decrease during the investment period. The internal rate of return on investment doesn't take into account the capital incurred during the previous investment & also the return on the previous investment.

LIMITATIONS OF THE INTERNAL RATE OF RETURN ON INVESTMENT

There are many limitations and misconceptions of the IRR. How it works is much different from the ROI although both can be quite similar. The most widely misplaced ideology of the IRR is the reinvestment rate of assumption.

The reinvestment rate assumption states that the IRR tends to assume the interim cash flows are reinvested into the internal rate of return on investment which is totally not true. It’s a major mistake that most traders have fallen prey to but is being corrected among the populace as of recent.

BENEFITS OF INTERNAL RATE OF RETURN ON INVESTMENT

There are many benefits of the internal rate of return on investment analysis. The most common importance of analyzing the IRR is as follows;

1. IRR doesn't require the trader to be a rocket scientist to understand the workings of the internal rate of return on investment.

2. Internal rate of return on investment also like the ROI sees the time worth of money.

3. Internal rate of return on investment  helps reduce the cost of capital

4. Internal rate of return on investment  helps in capital budgeting

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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