[CPA Slayer]

I read over it in the book. I am just not understanding what it is. Part of me says it is the rate of return you receive back when you invest in a project. I do not understand the NPV equaling 0. Also what would be a formula to better understand this concept.

Thanks for the help in advance.

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KO the test in 5 months even though I am a dummy!

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"But, in our defense, accountants aren't really boring people.
We just get excited over boring things."

[tuanxn]

You'll have to excuse me since I took Finance over the Summer and it's still a little fuzzy, but the IRR basically tells you what rate would be required so that the present value of your future earnings (a positive amount) equals the investment you're making now (a negative amount).

Say you have multiple projects you can invest in, but they all have different returns and different time frames.
The IRR lets you put all of them on an equal footing by calculating what their rate would be so that their NPV equals 0.

Using this comparison you can choose the project with the highest IRR because this would be the project that has the highest return.

Some numbers to make it easier (these calculations aren't correct, just go with it).

You invest $300 for a project that will yield $150 for 3 years and $10 salvage value.
The IRR turns out to be 24%
Which means the risk-free interest rate would have to be 24% for the present value of all those returns (3 years of $150 and the $10 salvage value) to equal $300, effectively earning you $0 in today's terms.

If another project has a higher IRR, you would choose that project, if not, you would choose this project.

Some limitations on the IRR is that you're required to have an initial investment followed by one or more cash flows. Also the IRR does not measure the absolute size of the project (thus you could have a higher IRR for a small project that provides smaller total profits than a larger project with a lower IRR that provides larger total profits).

[CPA Slayer]

Thank you so much!!! I finally got it down. I appreciate the help

FAR - 84
REG - 86
AUD - 90
BEC - 88

KO the test in 5 months even though I am a dummy!

Through God all things can happen!

"But, in our defense, accountants aren't really boring people.
We just get excited over boring things."

[Author]

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