Personal Finance & Money Asked on January 19, 2021
I can’t still completely understand the logic behind the calculation of IRR.
It’s all clear with NPV. Let’s use simple example:
NPV = CashFlow / DiscountRate
100 = 110 / 1,1
But with the IRR…, the definition of IRR says:
"To find the IRR, you would need to "reverse engineer" what discount
rate is required so that the NPV equals zero."
In this case: 0 = 110 / x => x = 110 / 0
So, how can such a discount rate exist at all, if the solution requires the division by zero?
The sum of the discounted cash flows (NPVs) should equal zero.
For example, you deposit £100 today (NPV) and expect to receive £110 next year. Discount £110 to NPV and sum the cash flows.
100 - 110/(1 + x) = 0
∴ x = 10 %
Answered by Chris Degnen on January 19, 2021
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