The Value of Internal Rate of Return

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Essay The Value of Internal Rate of Return. The work is to be 8 pages with three to five sources, with in-text citations and a reference page. As a method in evaluating capital budgeting decisions, its role can only be taken with seriousness since its wrong use could have disastrous consequences as companies make long term commitment to their resources. What is the IRR and what makes it useful? The internal rate of return is a rate used by companies to decide whether they should make investments by comparing the same with the cost of capital or hurdle rate. Whether it is a bond investment, stock investment or real estate, the return is measured in rates. No wonder it is a more preferred method of measuring the efficiency of an investment over that of the Net Present Value (NPV) method which uses value or magnitude in declaring whether an investment is acceptable or not. Its use with bonds on evaluating yield on investment is readily useful as a bond investment usually starts with an initial cash outflow and followed by a series of cash inflows. The same principle may be observed in the case of stocks if there is assured yearly distribution of dividends after the initial investments on stocks. Hence the same principle may be applied with other kinds of investments where there is an initial cash outflow that will be followed by a series of cash inflows. Since various investments attractiveness are expressed in rates of return, the use of IRR would allow a more convenient and easy way to make a decision by just taking the investment which will yield a rate higher one than the cost of capital or opportunity cost of an alternative investment which is also expressed in rates. Given the ease of its comparison, it has therefore advantaged over that of other methods like NPV. Another method that is expressed in rates from which it could be compared is the accounting rate of return (ARR) but since the latter does not consider the time value of money1, IRR then occupies a higher ground as that of the NPV. But since NPV is expressed in value as state earlier, more executives are using the same.

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