Question

2. a). Explain the statement related to IRR (Internal Rate of Return)“ the procedures for
computing the internal rate of return vary with the pattern of net cash flow”. If initial
investment is Rs. 100000 (one lakh) and the cash flow at the end of year 't' is Rs.
100945 when discount rate is 15% . When discount rate is increased to 16% the cash
flow at the end of year 't' is Rs. 98730. How will you interpret IRR and what would
your suggestion be for choosing one of the two projects?​

Answer 1

Answer:

The internal rate of return on investment or project is "annualized effective compounded return rate" or rate of return that sets net present value of all cash flows (both positive and negative) from investment equal to zero. Equivalently, it is the interest rate at which the net present value of the future cash flows is equal to initial investment, and it is also interest rate at which total present value of the costs (negative cash flows) equals total present value of benefits (positive cash flows).

IRR accounts for time preference of money and investments. A given return on investment received at given time is worth more than same return received at the later time, so the latter would yield the lower IRR than former, if all the other factors are equal. A fixed income investment in which money is deposited once, interest on this deposit is paid to investor at a specified interest rate every time period, and original deposit neither increases nor decreases, would have an IRR equal to specified interest rate. An investment which has the same total returns as preceding investment, but delays returns for one or more time periods, would have a lower IRR.

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