The relationship between Unit Internal rate of return and net present value and its calculation method
In investment decisionsFibaworldcup2022qualifiersphilippinesInvestors often need to evaluate the profitability of the project, in which unit internal rate of return (IRR) and net present value (NPV) are two important evaluation indicators. This paper will introduce the relationship between them and the calculation method of unit internal rate of return.
The relationship between Unit Internal rate of return and net present value
The unit internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of the project zero. In other words, IRR is the annualized rate of return that investors expect from the project without considering the value of time. Net present value (NPV) refers to the difference between the present value of the future cash flow of the project and the initial investment cost. When the NPV is greater than 00:00, it shows that the income of the project exceeds the cost of investment, and the investment is valuable.
From the perspective of mathematical relationship, there is a close relationship between IRR and NPV. When IRR is greater than the expected rate of return of investors, NPV is positive, the project has investment value; when IRR is less than the expected rate of return, NPV is negative, the project does not have investment value. Therefore, in the investment decision, investors usually consider IRR and NPV to judge the investment value of the project.
Calculation method of unit internal rate of return
To calculate the unit internal rate of return (IRR), you need to determine an appropriate discount rate so that the net present value (NPV) of the project is equal to zero. Here are two commonly used calculation methods:
The calculation method describes the trial and error method by trying different discount rates to find the IRR that makes NPV equal to zero. This method requires more calculation, but it is suitable for all types of cash flow. The interpolation method estimates the IRR that makes the NPV equal to zero when the NPV values at two different discount rates are known. This method is relatively simple to calculate, but it needs a certain mathematical basis.Take a simple investment project as an example, assuming that the initial investment cost of the project is 1 million yuan, and the cash inflows in the next five years are 300000 yuan, 400000 yuan, 500000 yuan, 600000 yuan and 700000 yuan respectively. We can use the above method to calculate the IRR of the project.
First of all, determine the cash flow statement: year cash inflow (ten thousand yuan) 0-1001 30 2 40 3 50 4 60 5 70 secondly, use trial and error method or interpolation method to calculate IRR. Suppose the discount rate we try is 15%, and the corresponding NPV is positive; the discount rate we try is 20%, and the corresponding NPV is negative. Therefore, we can conclude that the IRR of the project is between 15% and 20%. Through the calculation of interpolation method, the IRR is about 17.Fibaworldcup2022qualifiersphilippines.4%.Through the above analysis, we can get the relationship between the unit internal rate of return and the net present value and the calculation method of the unit internal rate of return. In the actual investment decision, investors need to combine the specific conditions of the project and comprehensively use indicators such as IRR and NPV to evaluate the investment value of the project.
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