Internal rate of return (IRR) refers to the rate of return that the project investment is expected to achieve. In essence, it is the discount rate that enables the project's net present value to be equal to zero.
The internal rate of return is the present value of the cash flow generated by an investment in the future, taking into account the time value, which is exactly the rate of return of the investment cost.
The general method of calculating the internal rate of return is the successive test method.
When the net cash flow after the project is put into production is in the form of ordinary annuity, the internal rate of return can be directly calculated by using the present value of the annuity. The formula is:
(P/A, IRR, n) = 1/NCF
The advantage of the internal rate of return is that it can directly reflect the actual income level of the investment project from a dynamic perspective, and is not affected by the industry benchmark rate of return, which is more objective. The shortcoming is that the calculation process is complicated, especially when a large amount of additional investment is made during the operation period, which may lead to the emergence of multiple IRRs, which are either high or low, and lack practical significance.
Only investment projects whose internal rate of return indicator is greater than or equal to the industry's benchmark rate of return or capital cost are financially viable.
Investment profit rate
The investment profit rate, also known as the return on investment (referred to as ROI), refers to the percentage of normal annual profit or average annual profit of the production period as a percentage of total investment. Its calculation formula is:
Investment profit rate (ROI) = annual profit / total investment × 100%
The advantage of investment profit rate is simple calculation; the disadvantage is that it does not consider the time value of capital, and can not correctly reflect the influence of the construction period and the different investment methods and the amount of recovery on the project. The comparability of the calculation of numerator and denominator is better. Poor, direct use of net cash flow information. Only investment projects whose investment profitability index is greater than or equal to the risk-free investment profit rate are financially viable.